Net Present Value (NPV): Definition, Formula, and How to Calculate It

Preparing financial statements is very important for business owners or even housewives. Many terms are very important when preparing financial statements, one of which is the net present value, or NPV. Understanding NPV in more detail will help you in assessing the best financial options.

By estimating net present value, you can improve your financial management and maximize future profits.

Therefore, in this article we will discuss what net present value is, how to calculate it, and examples of cases in calculating net present value in a financial statement.

1 What is Net Present Value?
2 Benefits of Using Net Present Value

3 What is the Net Present Value Calculation Formula?

3.1 The NPV formula for a single cash flow investment
3.2 NPV formula for projects with more cash flows and longer duration

4 What Elements Should Be Included in the Calculation of Net Present Value?

4.1 1. Annual net cash flow
4.2 2. Interest rate
4.3 3. Term

Ways to Use the Net Present Value Calculation Formula

5.1 Example one
5.2 Example two
5.3 Contoh tiga

6 What is the difference between NPV and IRR?

6.1 NPV
6.2 IRR

What is Net Present Value?

Net Present Value (NPV) is the difference between the present value of cash inflows and cash outflows during a certain period. In capital budgeting and investment planning, NPV is used to determine the profitability of a proposed investment or project.

Net present value (NPV) is the result of calculations used to determine the present value of future payment streams.

This analysis is often used by businesses in conjunction with cash flow predictions to offer an overview of the returns on investment.

Suppose the NPV of a project or investment is positive. In this case, the anticipated revenue from the project or investment will exceed the anticipated costs. On the other hand, if the net present value is, the projection will lose.

As a result, net present value is often calculated by a manager who is skilled or has a keen analysis of forecasted earnings for the next few years. If the projected income differs significantly from the forecast, then the NPV value will be incorrect.

Benefits of Using Net Present Value

NPVs serve multiple roles or provide significant advantages in the business sector or within corporations. Some of the net present value functions are as follows:

  • In business, this NPV calculation is used to determine the company’s capacity and opportunities to manage investments over the next few years. If the investment yields a profit, the plan will be carried out. On the other hand, if the investment prediction ends in future losses, the investment may be abandoned.
  • Net present value analysis used to assess the value of any investment, project or sequence of cash flows. This is a comprehensive statistic because it combines all income and capital costs associated with an investment into a free cash flow (FCF).
  • In addition, NPV can help businesses implement efficient budget management. Consequently, NPV can also be considered as the expected value of future investment returns.

What is the Net Present Value Calculation Formula?

The NPV calculation formula is a method for determining the profitability of investment by discounting the future cash flows of the investment to its present value. Unlike the Internal Rate of Return (IRR), the formula for calculating the NPV requires a discount rate (which we will discuss below the difference).

The NPV formula also depends on the interval and amount of future cash flows for the investment. This means that the formula for calculating the NPV for a short-term project with one cash flow is different from the formula for a multi-year investment with multiple cash flows.

NPV formula for a single cash flow investment

When calculating the NPV for a short-term project with a single cash flow, the only variables needed to obtain the present value are the cash flows, the time period of the cash flows, and the discount rate.

Here is the NPV formula for a one-year project with a single cash flow:

NPV = [Cash flow/ (1+i)^t] – initial investment


  • i = discount rate
  • t = number of time periods

NPV formula for projects with more cash flows and longer duration

For a long-term investment with multiple cash flows, the formula is pretty much the same, except that you would discount each cash flow individually and then add them together.

Here is the NPV formula for a long-term project with multiple cash flows:

NPV = Total present value of expected cash flows – initial investment

What Elements Should Be Included in the Calculation of Net Present Value?

To use the NPV calculation formula, you must include the following variables:

1. Annual net cash flow

You can estimate the net cash flow each year by adding the expected cash inflows from projected revenues to the potential savings in labor, materials, and other components of the initial project cost.

Then, subtract the costs incurred for the new project, that is, the cash outflows for one period. You should also add tax savings on depreciation of project assets to your expected cash inflows.

Cash inflows must be positive, while cash outflows must be negative. If the expected cash inflows exceed the outflows, you will have a net cash inflow. However, you will have an expected net cash outflow if the expected cash outflow exceeds the expected inflow.

2. Interest rate

The interest rate is also important for the calculation of NPV. Most managers use the discount rate to represent the interest rate, but it may also be referred to as the cost of capital, cutoff rate, required rate of return, and hurdle rate.

The interest rate or discount rate is the cost of capital or return that can be obtained in alternative investments. The interest rate can be lowered by comparing the rates of return on alternative investments or projects with similar initial costs.

The NPV of a project with a constant payment size and a fixed interest rate is usually direct and easier to calculate.

3. Term

The time period is the interval during which new cash flows are invested into a new project.

How to Use the Net Present Value Calculation Formula

What is the Difference Between NPV and IRR?

NPV and IRR both provide important information on capital budgeting and investment, but the metrics they generate should be used differently. Following are some of the differences between NPV and IRR:


  • Representation: NPV is represented as a dollar amount. It gives the amount of money that the project must generate for the company over a certain period of time.
  • Purpose: The purpose of NPV is to calculate the project surplus.
  • Decision making: NPV is generally a useful tool for investors, as its calculation takes many factors into account.
  • Project complexity: NPV is useful for projects that have multiple sources of cash and other complexities.
  • Discount rate: NPV uses a discount rate which can provide an unreliable calculation of value.


  • Representation: IRR is represented as a percentage. This gives the overall rate of return on the project for the company over a certain period of time.
  • Objective: The purpose of the IRR is to calculate the break-even cash flow rate of a project.
  • Decision making: IRR is not considered a useful tool for investors because its calculation relies on a very small collection of information.
  • Project complexity: IRR is useful for simple projects that have only one source of funding and no other complexity.
  • Discount rate: IRR uses the underlying actual cash value rather than the discount rate, which leads to more reliable results.

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