Plain definition
Net present value, or NPV, asks a simple question: after allowing for when cash arrives and the return required for its risk, does a project add value today? It is the present value of all relevant future incremental cash inflows less the present value of all relevant cash outflows.
“Incremental” matters. Use cash that changes because of the decision: the purchase price, extra sales, extra operating cost, tax, working-capital movements, and disposal proceeds. Do not include a research bill already paid; that is a sunk cost. Do not substitute accounting profit for cash flow.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
Suppose a company pays for a machine today and expects of after-tax cash in one year. At a 10% required return, the future cash has a present value of because ÷ 1.10 = . NPV is : − .
The result is not produced by calling “profit.” It comes from discounting a dated cash flow, then comparing that value with the cash committed today.
| Future after-tax cash flow | |
|---|---|
| Discount factor (1 ÷ 1.10) | |
| Present value |
| Present value of future cash | |
|---|---|
| Initial cash outlay | |
| Net present value |
If the project requires additional working capital, forecast when it is paid and when it is released. Do not assume its eventual release will by itself make the NPV negative or positive.
Why it matters
A manager can be drawn to a large sales forecast or a fast payback while missing the cash tied up before those sales arrive. NPV makes the timing and scale of every cash consequence visible, so alternatives of different sizes and dates can be compared on one value basis.
Practical consequence
Build one dated cash-flow schedule before calculating NPV. For every line, record why it changes if the project is approved, when it occurs, and whether it is an inflow or outflow. Then test the demand, cost, timing, and discount-rate assumptions that could move NPV below zero. Use the result with strategic constraints and execution capacity; NPV does not decide whether the business can deliver the project.