Analysis In Business
What is NPV?
When you ask "What is NPV?", you must first realize that it is an acronym which stands for net present value. In broad terms net present value (NPV) is a way taking a set of cash flows and determining if they are economically favorable. Being economically favorable means that we want to know which ones will make us the most money or cost us the least. The net present value provides with a single number that summarizes the string of cash flows and provides an answer to it's value.
The Time Value of Money
To understand NPV we need to first understand the concept of time value of money. In simple terms the time value of money assumes that money that you have today is more valuable than money that you have some time in the future. The amount of difference in value is determined by the hurdle rate.
Here is an example:
If I have a savings account in which I deposit $100, and I receive annual interest of 3%, then I would have $103 at the end of one year. Now it would appear that since $103 is more than $100 that the future value of that savings account in one year would be more valuable than the present value today. The problem is that you don't have access to the $100 for one year. What is your sacrifice worth? Well, you have assigned a value of $3 to not being able to use your money for one year. You assigned that value by opening the savings account that pays you 3% interest. With that assignment you effectively made the value at the end of the first year equal to value at the start with a discount rate of 3%.
So the variables of our example are: Present Value (PV) = $100 Future Value (FV) = $103 Interest Rate (i) = 3% Years or Periods (n) = 1
Time Value of Money Calculator
So if we had a time value of money calculator, we could plug at least 3 of these variables into it to get the 4th. The TVM calculator is just a financial calculator. Many financial calculator apps are available for your smart phone. You may also have a hardware calculator that has financial functions. Finding present value with a financial calculator is easy. You simply enter 3 variables and then press the button for the 4th variable and you will have the missing variable. The one caveat is to play close attention to the + and - signs of your variables. So a calculator with financial functions is really a time value of money calculator. So you can find present value with a calculator. Also you can find future value with a calculator. You probably won't find a calculator able to find NPV.