Wednesday, May 23, 2012

What is Net Present Value (NPV)?

Net Present Value (NPV) is a very important concept in Accounting

Net Present Value (often referred to as NPV by accountants), is a financial concept used in making different financial choices. Basically, it is an easy a way for accountants to express a decision in "today's dollars".

For an accountant to calculate net present value (NPV), they must use the difference between the present value (PV) of cash inflows and the current value of cash outflows by a company.

NPV is defined mathematically as the present value of cash flow less the initial outflow n NPV= Σ Ct - Co t=1 (1+k)t

Most often, NPV is used in capital budgeting type analyses to analyze the profitability of a potential investment, project, or product line that a company is thinking about undertaking in the future.

Generally,  if the NPV of a prospective project is positive, it should be accepted by management or the relevant decision makers in a department.  However, if NPV is negative, the project should probably be rejected because cash flows in the future will be negative and the company will experience net losses on the project. The company may still undertake the project if there are other non-financial accounting reasons.

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