What Is Net Present Value (NPV)?
Net present value is the sum of a project's discounted future cash flows less the initial investment. A positive NPV adds value. Here's how it works and why it's the preferred appraisal method.
Net present value (NPV) is the sum of a project's future cash flows, each discounted back to today, less the initial investment. It tells you how much value a project adds in today's money. The rule is simple: a positive NPV means the project is expected to increase shareholder wealth and should be accepted.
How is NPV calculated?
- Estimate the relevant, incremental cash flows for each year of the project.
- Discount each year's cash flow using the appropriate discount rate (often the cost of capital).
- Add up the discounted cash flows and subtract the initial investment.
The discount rate reflects the time value of money and the project's risk — money received later is worth less than money received today.
Why NPV is preferred
NPV is regarded as the theoretically superior appraisal method because it uses cash flows (not accounting profit), accounts for the time value of money, considers the whole project life, and directly measures the change in shareholder wealth. That's why it usually outranks payback and accounting rate of return.
NPV in ACCA FM and AFM
FM and AFM test NPV constantly, including tax, inflation, working capital and — at AFM — more advanced variants like APV. The marks come from a clear, well-laid-out proforma and correct treatment of each cash flow, with method marks available even if a figure slips. Practising full NPV questions and marking them against the official ACCA scheme with The 50% Club is the fastest way to secure those marks.