What is net present value (NPV)?

NPV or the net present value shows the difference between the present value of future cash flows and the current investment. We derive the present value of expected cash flows by discounting them at a specified rate of return. NPV is a widely used cash-budgeting method for assessing projects and investments.

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To understand this term better, you first need to understand the term present value. For example, imagine that you want to have ₹25,000 in your account next year and the yearly interest rate on that account is 10%. This means that you need to deposit ₹22,500 in that account today to have ₹25,000 twelve months from now. The present value of ₹25,000 due in 12 months is ₹22,500.

 

Also note that for a positive discount rate, the future value (FV) is always higher than the present value (PV).