Net Present value
is the difference between the present value of cash inflows and the present values of cash outflows. It is used in capital budgeting to analyze the profitability of an investment.
The formula for NPV is,
In other words, NPV compares the value of money today and the value of the same amount of money in the future. If the NPV is positive for a project or an investment then we can accept it. If the NPV is negative then reject the project.
if a retail grocery business wants to purchase an existing store, it would first estimate the future cash flows that store would generate, and then discount those cash flows into one lump-sum present value amount, say $600,000. If the owner of the store was willing to sell his business for less than $600,000, the purchasing company would likely accept the offer as it presents a positive NPV investment. Conversely, if the owner is not willing to sell for less than $600,000, the purchaser would not buy the store, as the investment would present a negative NPV at that time and would, therefore, reduce the overall value of the business.
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