gen-define-net-present-value-and-give-one-short-worked-example-6125

Define net present value and give one short worked example.

# Net Present Value (NPV) **Definition:** Net Present Value is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. It's used to evaluate the profitability of an investment by discounting all future cash flows to today's dollars. **Formula:** NPV = Sum of [Cash Flow / (1 + r)^t] - Initial Investment Where: - r = discount rate - t = time period ## Worked Example A company considers buying equipment for $10,000 that will generate: - Year 1: $4,000 - Year 2: $5,000 - Year 3: $3,000 Discount rate = 10% **Calculation:** NPV = -$10,000 + $4,000/(1.10)¹ + $5,000/(1.10)² + $3,000/(1.10)³ NPV = -$10,000 + $3,636 + $4,132 + $2,254 **NPV = $22** **Interpretation:** Since NPV is positive ($22), the investment would add value and should be accepted. If NPV were negative, the investment should be rejected.