What NPV means
NPV (Net Present Value) measures the value created by an investment after discounting future cash flows back to today. If NPV is positive, the investment exceeds your required return (discount rate).
NPV formula
NPV = sum(cash flow_t / (1 + r)^t) - initial investment
How to calculate NPV (step-by-step)
- List expected cash flows by year (or month).
- Choose a discount rate (your required return / MARR).
- Discount each cash flow back to present value.
- Sum discounted cash flows and subtract the upfront investment.
NPV example
If you invest $100k today and expect $30k per year for 5 years at a 12% discount rate, the NPV is about $8.1k (positive value created).
Sensitivity and scenario checks
- Test a range of discount rates to see how sensitive NPV is to risk.
- Use downside and upside cash flow scenarios instead of a single base case.
- Check for timing risk: delays can cut NPV even if totals look strong.
NPV QA checklist
- Use consistent time units (monthly vs annual) for cash flows and rate.
- Separate one-time capex from ongoing cash flows.
- Avoid mixing nominal and real cash flows without adjusting the rate.
Common mistakes
- Using an unrealistic discount rate (test a range).
- Ignoring risk differences across projects (one rate doesn't fit all).
- Mixing nominal and real cash flows (inflation consistency).