Net present value (NPV) tells you whether an investment creates or destroys value
by comparing the present value of future cash flows to the upfront cost.
Positive NPV means the investment creates value above the required return.
NPV decision rules
NPV
Decision
Positive (NPV > 0)
Accept — creates value above required return
Zero (NPV = 0)
Break-even — earns exactly required return
Negative (NPV < 0)
Reject — destroys value at this discount rate
Profitability Index (PI)
PI = (NPV + Initial Investment) / Initial Investment
PI measures value created per dollar invested. PI > 1 = positive NPV. Useful
for ranking competing projects when capital is constrained: higher PI means more
value per dollar of capital deployed.
PI
Interpretation
> 1.5
Excellent return
1.1–1.5
Good return
1.0–1.1
Marginal return
< 1.0
Destroys value
Choosing the right discount rate
The discount rate is the most critical input — small changes have large effects.
Corporate WACC: Weighted average of debt cost (after-tax) and equity cost.
Typical range: 8–12% for established businesses.
Venture/startup: Higher rates (20–30%) reflect higher risk. A startup might
require 25% return to compensate investors for failure risk.
Hurdle rate: Many companies set a minimum acceptable IRR (15–20%) for projects
to compete for capital allocation.
When uncertain, run NPV at multiple discount rates (sensitivity analysis).
NPV vs IRR
IRR (Internal Rate of Return) is the discount rate at which NPV = 0.
Both measure project value; NPV is generally preferred because:
- NPV is in dollar terms (easier to interpret)
- IRR can give multiple values for unconventional cash flows
- NPV correctly handles varying discount rates over time
Frequently asked questions
What does this calculator do?
Calculate NPV from an initial investment and up to 5 years of cash flows. Enter
your discount rate (cost of capital) and projected annual cash flows.
What Is Net Present Value (NPV)? Formula, Examples, and Decision Rules
NPV discounts future cash flows to their present value and subtracts the initial investment. Learn the formula, when to use it, and how to choose the right discount rate.
Net Present Value (NPV) answers the most fundamental question in capital allocation:
does this investment create value or destroy it?
Where r is the discount rate (cost of capital) and t is the year.
A positive NPV means the investment earns more than your required return.
A negative NPV means it earns less. The rule: accept all positive-NPV projects.
Why we discount cash flows
A dollar today is worth more than a dollar in the future. If you can earn 10%
per year, $1,000 today becomes $1,100 in one year. Equivalently, $1,100 in one
year is worth $1,000 today at a 10% discount rate.
NPV applies this logic to all future cash flows from an investment:
- Year 1 cash flow is discounted by (1 + r)^1
- Year 2 cash flow by (1 + r)^2
- And so on...
The sum of discounted cash flows, minus the initial investment, is the NPV.
A worked example
Investment: $100,000
Cash flows: $30k, $35k, $40k, $40k, $40k over 5 years
Discount rate: 10%
Year
Cash Flow
Discount Factor
Present Value
1
$30,000
1/1.10 = 0.909
$27,273
2
$35,000
1/1.21 = 0.826
$28,926
3
$40,000
1/1.331 = 0.751
$30,053
4
$40,000
1/1.464 = 0.683
$27,321
5
$40,000
1/1.611 = 0.621
$24,837
Total PV
$138,410
NPV = $138,410 − $100,000 = $38,410
Positive NPV → accept. This investment creates $38,410 in value above the required 10% return.
NPV decision rules
NPV
Interpretation
Positive
Investment creates value — accept
Zero
Investment exactly meets required return
Negative
Investment destroys value — reject
For competing projects with limited capital, rank by Profitability Index (PI = NPV/Investment).
NPV vs IRR: Which Metric to Use for Investment Decisions
NPV and IRR both evaluate investment returns, but they answer different questions. Learn when each is appropriate and why NPV is generally preferred for capital allocation decisions.
NPV and IRR are both tools for evaluating investment returns, but they answer
slightly different questions and can sometimes give conflicting signals.
NPV: value in dollars
NPV = −Investment + Σ [Cash Flow / (1 + r)^t]
NPV answers: "At my required rate of return, how many dollars of value does this
investment create?" The result is an absolute dollar figure.
NPV is directly actionable: accept all positive-NPV projects. When comparing two
projects, the one with higher NPV creates more wealth (assuming the same scale).
IRR: the break-even return rate
IRR is the discount rate at which NPV = 0. It answers: "What rate of return does
this investment actually earn?" It's expressed as a percentage.
For the example project ($100k investment, $30k–$40k annual cash flows over 5 years),
IRR ≈ 21.5%. This means the project earns 21.5% annually.
If your hurdle rate is 10%, IRR > 10% → accept. If hurdle rate is 25%, IRR < 25% → reject.
When NPV and IRR agree
For simple investments (one outflow, then inflows), NPV and IRR always agree on
the accept/reject decision:
- Positive NPV ↔ IRR > discount rate
- Negative NPV ↔ IRR < discount rate
When they disagree: mutually exclusive projects
When choosing between two competing projects, NPV and IRR can give different rankings.
How to Choose the Right Discount Rate for NPV Calculations
The discount rate is the most important input in NPV analysis. Learn how to calculate WACC, hurdle rates, and opportunity cost — and why the wrong rate leads to bad decisions.
The discount rate is the single most critical input in NPV analysis. Choose too low
and you'll accept bad investments. Choose too high and you'll reject good ones.
The concept: opportunity cost of capital
The discount rate represents what you could earn by investing money elsewhere
at similar risk. If you can earn 10% in the stock market at similar risk, any
project that doesn't earn at least 10% destroys value relative to the alternative.
Key principle: the discount rate should reflect the risk of the project,
not the risk of the investor or the company's average projects.
Method 1: WACC (Weighted Average Cost of Capital)
For businesses with both debt and equity financing:
WACC = (E/V × Re) + (D/V × Rd × (1 − Tax Rate))
Where:
- E/V = equity weight (equity / total value)
- Re = cost of equity (e.g., 12–15% for a small business)
- D/V = debt weight
- Rd = cost of debt (interest rate on loans)
- Tax rate = corporate tax rate (interest is tax-deductible)
Many companies set a minimum acceptable IRR for projects (the "hurdle rate").
This is a policy decision, not a formula. Common hurdle rates:
- Large corporates: 12–15%
- Mid-market companies: 15–20%
- Startups and high-risk projects: 20–30%
- Venture capital: 30–40%
Method 3: Risk-adjusted rate
For projects with different risk profiles from your core business:
- Low risk (cost savings, operational improvements): WACC − 2–3%
- Average risk (core business expansion): WACC
- High risk (new markets, unproven technology): WACC + 5–10%
- Speculative (moonshot projects): 25–40%
Common mistakes
Using the cost of debt only: "Our loan rate is 7%, so we use 7%." Wrong —
this ignores the cost of equity, which is significantly higher than debt.
Using a fixed rate for all projects: A stable manufacturing investment is not
the same risk as a software startup. Same company, different risk, different rate.
Using the nominal rate for real cash flows: If cash flows are in inflation-
adjusted (real) terms, use a real discount rate. If nominal, use nominal.
For most business decisions, start with WACC and adjust up for higher-risk projects.
If uncertain, run sensitivity analysis: calculate NPV at 8%, 12%, 16%, and 20%.
Use the NPV Calculator to model different discount rate scenarios.