How to Calculate NPV (Net Present Value) and Use It to Decide
Learn how net present value works, how to choose a discount rate, and how NPV, IRR and payback compare when judging an investment, with a free calculator.
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Free tool: NPV CalculatorNet present value (NPV) answers a simple question: after accounting for the time value of money, is an investment worth more than it costs? It converts future cash flows into today's dollars and subtracts the upfront cost. This guide explains how NPV works with a worked example, using the free NPV Calculator.
The formula
NPV = −initial investment + Σ cash flow in year t ÷ (1 + r)^t
where r is the discount rate: the return you require, or your cost of capital. A dollar received in five years is worth less than a dollar today, and the discount rate sets how much less.
Example
A project costs $15,000 today and is expected to bring in $3,000, $4,000, $4,000, $5,000 and $5,000 over the next five years. At an 8% discount rate:
- Present value of the cash flows: $16,460.53
- NPV: $16,460.53 − $15,000 = $1,460.53
A positive NPV means the project earns more than 8% a year, so it adds value at that required return.
The discount rate matters
The same cash flows at higher rates:
| Discount rate | NPV |
|---|---|
| 8% | $1,460.53 |
| 10% | $557.99 |
| 12% | −$270.81 |
| 15% | −$1,392.01 |
The rate where NPV crosses zero is the internal rate of return (IRR), here about 11.33%. If your required return is above that, the project doesn't pay.
Choose a rate that reflects the risk: what you could earn elsewhere at similar risk, or your company's cost of capital.
NPV, IRR, profitability index and payback
- NPV: the value added in today's dollars. Accept projects with a positive NPV.
- IRR: the project's own rate of return. Accept if it beats your required return.
- Profitability index: present value of inflows ÷ investment, 1.097 here. Above 1 means a positive NPV; useful for ranking projects with a limited budget.
- Payback: how long until the cash flows repay the investment, 3.8 years here, or 4.6 years counting the discounting.
When projects compete, NPV is usually the most reliable guide, because IRR can mislead with unusual cash flows and payback ignores everything after the payback date.
How to use the NPV Calculator
- Open the NPV Calculator.
- Enter the discount rate and the initial investment.
- Enter each year's cash flow, adding or removing years as needed. Use negative numbers for years with costs.
- Read the results: the net present value, the internal rate of return, the profitability index and the simple and discounted payback periods, with a discounted cash flow table and charts of actual vs discounted cash flows and NPV at different discount rates.
For a single payback analysis with growing cash flows, see How to Calculate the Payback Period.
Frequently asked questions
What does a positive NPV mean?
That the investment returns more than your discount rate, adding value in today's dollars. A negative NPV means it returns less.
What discount rate should I use for NPV?
Your required return for the risk involved, often your cost of capital or the return on an alternative investment of similar risk. Riskier projects deserve higher rates.
What is the difference between NPV and IRR?
NPV is a dollar amount at a chosen rate; IRR is the rate that makes NPV zero. In the example, NPV is $1,460.53 at 8%, and the IRR is about 11.33%.