Net Present Value (NPV): so how do you calculate net present value? NPV is calculated as a sum of cash flow through project life cycle adjusted to the discount interest rate. It is calculated to estimate the net benefit of a project and other types of multi-year engagements. The NPV diagram below visually depicts the overall calculation methodology.
NPV is a key finance tool. Usually, the initial cashflow is negative due to the investment required (e.g. purchase of new equipment). As time progresses, the company starts to generate positive cash flow. The further away is the cashflow, the more discounted it becomes (i.e. cash today is worth more than the same amount of cash in the future). Therefore some projects that seem to generate excessive returns in the future may actually have a negative NPV as their future cashflows do not offset current costs.