Net present value

Net present value (NPV) describes the current value of a cash balance or a payment that will not be received until the future. The underlying logic is as follows: money you have today is more valuable than the same amount in the future. On the one hand, this is because you can invest today’s capital to earn interest or dividends. On the other hand, inflation reduces the purchasing power of future amounts.

To calculate the net present value, one uses discounting. This involves converting future sums back to the present using an imputed interest rate. The further a payment lies in the future or the higher the market interest rate, the lower its present value will be.

In practice, present value is indispensable for evaluating investments. A project is considered economically viable only if the sum of the present values of all expected revenues exceeds today’s acquisition costs. This allows for an objective comparison of different financial options.