Net Present Value (NPV) for Project Managers

Posted on September 3, 2009 by

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Projects have a starting date and an ending date—but that does not mean they are short! When comparing potential long-term projects, Net Present Value (NPV) is a financial valuation technique to help indicate which project may represent the best financial investment. If a 1-week project is expected to have a $10,000 profit, it may be a great choice. But what if a 30-year project is expected to have a $10,000 profit? Or how about a 50 or 100 year project? What should become obvious is that $10,000 in today’s money is not worth the same as $10,000 in the future. NPV accounts for this change in the worth of money and examines the value of money in terms of how much it is worth today. Technically, it is the total present value of a time series of cash flows. This means that for a given number of years, for each year we examine the difference between the cash inflow and cash outflow and adjust it for the rate of return. The sum of each year (the present value) is added together to obtain the total Net Present Value. If the NPV is positive, it is expected that the project will lead to a profit; whereas if it is negative, the project is expected to lose money.

For practice on calculating NPV, see TAPUniversity’s WEMSHA workbook, Exercise 10, page 44. Also see the earlier postings of Payback Period (posted March 16) and Cost-Benefit Analysis (posted May 7, 2009).