Interpreting the NPV
A positive NPV means the investment makes sense financially, while the opposite is true for a negative NPV.
Learning Objective

Interpret a series of net present value calculations
Key Points
 When inflows exceed outflows and they are discounted to the present, the NPV is positive. The investment adds value for the investor. The opposite is true when NPV is negative.
 A NPV of 0 means there is no change in value from the investment.
 In theory, investors should invest when the NPV is positive and it has the highest NPV of all available investment options.
 In practice, determining NPV depends on being able to accurately determine the inputs, which is difficult.
Term

cash flow
The sum of cash revenues and expenditures over a period of time.
Full Text
The NPV is a metric that is able to determine whether or not an investment opportunity is a smart financial decision. NPV is the present value (PV) of all the cash flows (with inflows being positive cash flows and outflows being negative), which means that the NPV can be considered a formula for revenues minus costs. If NPV is positive, that means that the value of the revenues (cash inflows) is greater than the costs (cash outflows). When revenues are greater than costs, the investor makes a profit. The opposite is true when the NPV is negative. When the NPV is 0, there is no gain or loss.
In theory, an investor should make any investment with a positive NPV, which means the investment is making money. Similarly, an investor should refuse any option that has a negative NPV because it only subtracts from the value. When faced with multiple investment choices, the investor should always choose the option with the highest NPV. This is only true if the option with the highest NPV is not negative. If all the investment options have negative NPVs, none should be undertaken.
The decision is rarely that cut and dry, however. The NPV is only as good as the inputs. The NPV depends on knowing the discount rate, when each cash flow will occur, and the size of each flow. Cash flows may not be guaranteed in size or when they occur, and the discount rate may be hard to determine. Any inaccuracies and the NPV will be affected, too .
Machinery
Being able to accurately find the NPV of a piece of machinery means having a good idea when all costs are going to occur (when it will need fixing) and when it will generate revenue (when it will be used on a job).
Key Term Reference
 Present Value (PV)
 Appears in these related concepts: The Discount Rate, Par Value at Maturity, and Defining the Time Value of Money
 discount
 Appears in these related concepts: Advantages of the NPV method, Present Value, Multiple Flows, and Answers to Chapter 10 Questions
 discount rate
 Appears in these related concepts: Discounted Cash Flow Approach, The Discount Rate, and The Federal Reserve and the Financial Crisis of 2008
 investment
 Appears in these related concepts: Functions of Corporate Finance, The Role of the Financial System, and GDP Equation in Depth (C+I+G+X)
 investor
 Appears in these related concepts: Advantages of Private Financing, Agency, and Financial Instruments
 metric
 Appears in these related concepts: Return on Total Assets, The Relativistic Universe, and Industry Comparisons
 present value
 Appears in these related concepts: Capital Leases vs. Operating Leases, Calculating Values for Different Durations of Compounding Periods, and Present Value and the Time Value of Money
Sources
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