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Net Present Value (NPV) and Internal Rate of Return (IRR)

Net present value (NPV) Net present value (NPV) for a particular investment is the sum of the annual cash flows, revenues and costs, during the time horizon of the project, discounted to the date of the investment minus the investment outlay.

In other words Net Present Value of an investment is the present value of the stream of annual revenue (PVR) minus the annual stream of costs (PVC) after deducting the initial investment. The terms cost and operating expenses are used in the same context.

NPV = ((discounted future streams of revenues and costs) minus (initial Investment)) = (PV – Investment)

In order to fully understand and apply the concept of Net Present Value (NPV) we must understand, first, the value of money over time and the present value of an investment, namely, bring back to the date of the investment the discounted future streams of revenue and costs, that occur over time horizon of the investment, during several years.

Definition: Present Value (PV) of an inflow or an outflow of cash at a future date, as a result of the investment, is the discounted amount of these inflows and outflows at the date of investment. This value is calculated using a discount factor that includes the market cost of capital plus the risk of investing in the firm.

Net present value (NPV) for a particular investment is the sum of the annual cash flows, revenues and costs, during the time horizon of the project, discounted to the date of the investment minus the the investment 

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