What is net present value (NPV)? Formula and how to calculate

Net present value (NPV) is a critical financial metric used to assess the profitability of an investment by comparing the present value of expected future cash flows against the initial investment cost. A positive NPV indicates that an investment is likely to be profitable, while a negative NPV suggests the opposite. Calculating NPV involves considering several factors, such as the discount rate, cash flow projections, timing, capital expenditures, and project risk, all of which can significantly influence the outcome. While NPV is a valuable tool for decision-making, it has limitations, including sensitivity to cash flow projections and discount rates, and it often focuses on short-term gains without accounting for non-financial factors. Despite these limitations, NPV can help in evaluating product decisions, determining optimal pricing, and assessing the impact of potential changes. It is often used alongside other metrics like internal rate of return (IRR) to provide a more comprehensive understanding of an investment's financial viability.