The difference between an investment's present value and its associated costs is known as net present value, or NPV. The bullet points listed below appropriately describe the function of NPV.
In contrast to other capital budgeting analysis methods, the NPV formula utilizes the time value of money; it discounts cash flow and examines profitability depending on the timing of when cash flow occurs. The discount rate used in the NPV method also accounts for the particular cost of capital for the company.
The NPV calculation inherently incorporates long-term exposure to risk because it discounts cash flow. Since these cash flows frequently have the greatest degree of uncertainty, the most distant estimates in the future are discounted most heavily.
The NPV formula frequently yields a result that is simple to understand. The project is profitable if the results are favorable. If the results are unfavorable, the project will not be profitable. The NPV formula generates value on its own, as opposed to the IRR formula, which generates a percentage that must be measured against a benchmark.
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