Project Selection – Net Present Value (NPV)

 

Definition

Net Present Value (NPV) of the sum of all cash inflows (in Present Value) of the project minus the initial cost, i.e.  PV (benefits) – PV (costs) (Read more)

NPV is an effective tool to help determining whether a project will be profitable,

• NPV > 0 – the project is profitable
• NPV = 0 – the project will break even
• NPV < 0 – the project will lose money

Sample Question

For the software project, $100,000 would be needed which is expected to generate a total of $200,000 (in present value) over 5 years. What is the Net Present Value (NPV) of the project?

A. $100,000
B. $200,000
C. $300,000
D. -$100,000

Solution: A

Since the Net Present Value (NPV) is the present value of all benefits minus all costs, i.e. NPV = $200,000 – $100,000 = $100,000.

Higher the better

The larger the Net Present Value (NPV), the more profitable the project is to the organization.