How we calculate the value of that money and why Net Present Value is a term that will be useful for us in calculating that value is what we will study on this page. The money received in the future is also less valuable as inflation will erode its purchasing power in the future. This is because the money we have right now is the money we will use to invest in various junctures like opening a business, or buying a property now and selling it later for a higher price, or simply just putting that money in the bank and earning interest. Hence, the firm should invest in project Y.Īs we go through the basic financial concepts of time, value and money, we realize that the money we have now is more valuable than the money we will collect in the future. We can see, the NPV of project Y is greater than the NPV of project X. Therefore, NPV of the project Y at 10% is $1004.01 In case of even cash flows, the following NPV formula can be used: It considers the interest rate, which is generally equivalent to the inflation rate, Hence, the real value of money now at each year of operation is considered.įollowing are the formulas used to calculate NPV. NPV is a strong approach to determine if the project is profitable or not. In other words, it is the difference between the present values of cash inflows and the present value of cash outflows over some time. Net Present Value or NPV is the sum of the present value of cash inflows and outflows. Let us discuss what net present value is. But how do you compare the value of money now with the value of money in the future? This is where net present value plays an important role. The money received in the future is also less valuable because inflation erodes its purchasing power. This is because you can use it now to earn more money by running a business or buying something now and selling it later for more, or simply putting it in the bank and earning more interest. The basic financial concept of time value money states that the money you have known is more valuable than the money you collect later on.
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