NPV in 2 Easy Steps

What this NPV lesson covers

• What NPV actually measures, in plain English
• The NPV formula and what each symbol means
• Step 1: discount each cash flow back to today
• Step 2: add them up and subtract the upfront cost
• How to use NPV to accept or reject a project

NPV formula, explained

How to calculate NPV step by step (worked example)

A project costs $1,000 today and pays $400, $500 and $300 at the end of years 1, 2 and 3. The discount rate is 10%. What is the NPV?

1. Year 1: 400 ÷ 1.10 = 363.64
2. Year 2: 500 ÷ 1.10² = 413.22
3. Year 3: 300 ÷ 1.10³ = 225.39
4. Add them: 363.64 + 413.22 + 225.39 = 1,002.25
5. Subtract the cost: 1,002.25 − 1,000 = 2.25

Answer: NPV ≈ $2.25 (rounded to the cent). It is positive, so the project just clears the 10% required return and is acceptable.

NPV vs IRR vs payback period: what's the difference?

Can you trust a 10-year NPV today? David's take

NPV quietly assumes you know how long the cash keeps coming. Product life cycles used to be around 50 years; in the internet age, more like 15. With AI, digital products may get 50 months, or even 50 weeks. That's a catchy line, not a statistic, but the direction is real. In the example, the project is worth +$2.25 over three years. If the product dies after two years, NPV becomes −$223. So do the NPV, then stress-test the lifespan, and favour projects that pay back fast. That's the idea behind my concept 'Guerrilla Producting'.

From David's concept: Guerrilla Producting (product lifecycle compression). This is David's opinion, alongside the standard textbook answer above.

Harder NPV questions

What happens to NPV if the product's life is shorter than forecast?

Every lost year removes a whole discounted cash flow. In the lesson's example, cutting the life from three years to two drops NPV from +$2.25 to about −$223 (363.64 + 413.22 − 1,000). Testing a shorter life is one of the most useful sensitivity checks.

Why do NPV and IRR sometimes rank two projects differently?

IRR ignores size. Project A costs $1,000 and returns $1,500 in a year (IRR 50%, NPV at 10% ≈ $364). Project B costs $5,000 and returns $6,500 (IRR 30%, NPV ≈ $909). IRR prefers A; NPV prefers B, which adds more value. When the two disagree on mutually exclusive projects, go with NPV.

Is a project with an NPV of just $2 really worth doing?

On paper, yes: it clears the required return. In practice, a small positive NPV can flip negative with a tiny forecast error, so check how sensitive it is to the discount rate, the cash flows and the project's life before committing.

Common NPV questions

What is the formula for NPV?

NPV = Σ CFₜ ÷ (1 + r)ᵗ − C₀. Discount each future cash flow by (1 + r) raised to the year number, add up those present values, then subtract the initial investment C₀ paid today.

What does a positive NPV mean?

A positive NPV means the project's cash flows, in today's money, are worth more than it costs. It earns more than the discount rate, so it adds value and should be accepted. A negative NPV means it destroys value.

What discount rate should I use for NPV?

Use the project's required rate of return, which is often the company's cost of capital (WACC) for projects of normal risk. Riskier projects deserve a higher rate. In exams, the rate is usually given to you.

What is the difference between NPV and present value?

Present value converts one future amount into today's money. NPV does that for every cash flow in a project, adds them together, and nets off the upfront cost. NPV is basically many present values combined into one number.