Should you invest $100,000 in a business that pays back $30,000/year for 5 years? Should you buy that rental property? Learn how NPV helps you make smarter investment decisions with real examples.
⏱ 10 min read💼 3 real-world examples📝 3 practice problems🧮 Calculator integration
What Is Net Present Value?
Someone offers you a business investment: "Put in $100,000 today and you'll get $30,000 every year for 5 years." That's $150,000 total—sounds like profit! But is it really?
The catch: that future money isn't worth as much as today's $100,000. NPV (Net Present Value) converts all future cash flows to today's dollars, then subtracts your initial investment. If NPV is positive (+), the investment is worth it. If it's negative (−), you'll lose money.
Each year's cash flow is discounted to present value (at 10%), then summed and reduced by the initial investment
NPV Formula
NPV = −C0 + C1/(1+r) + C2/(1+r)2 + … + Cn/(1+r)n
C0 = initial investment, Ct = cash flow in year t, r = discount rate
NPV Decision Rule
NPV > 0 → Investment is worth it. You make money after accounting for time value NPV = 0 → Break-even. Decide based on other factors (risk, alternatives) NPV < 0 → Don't invest. You'll lose money in today's dollars
Core principle: TVM converts future money to today's value, then NPV applies it to investment decisions.
How to Choose the Discount Rate
The discount rate is "what return I'd earn if I invested this money elsewhere" Conservative investor (savings account) → 3−4% Stock market investor → 8−10% Business owner (higher risk) → 15−20%
You're considering buying a rental property for $300,000. You expect:
Annual rental income: $25,000/year for 10 years
Property sale price after 10 years: $350,000
Your required return (discount rate): 8%
Rental Property NPV Calculation
Initial investment: −$300,000 Year 1−10 rental income: $25,000/year, discounted at 8% Year 10 sale proceeds: $350,000, discounted at 8%
Result: NPV = +$47,200
The investment returns more than your 8% requirement. It's a good investment.
Real-World Example 2: Equipment Investment for a Business
Your manufacturing business can buy new equipment for $200,000 that will:
Increase annual profits by $60,000 for 5 years
Be sold for $40,000 scrap value at year 5
Your cost of capital (discount rate): 10%
Equipment Investment NPV Calculation
Initial investment: −$200,000 Year 1−5 profit increase: $60,000/year, discounted at 10% Year 5 scrap value: $40,000, discounted at 10%
Result: NPV = +$27,500
Worth it. The equipment pays for itself and generates $27,500 in value.
Real-World Example 3: Solar Panel Installation
You want to install solar panels on your house:
Installation cost: $15,000
Annual electricity savings: $1,800/year for 20 years
Your discount rate: 6%
Solar Panel NPV Calculation
Initial investment: −$15,000 Year 1−20 savings: $1,800/year, discounted at 6%
Result: NPV = +$7,800
The electricity savings will exceed the installation cost. Recommended investment.
NPV vs IRR: When to Use Each
Both metrics help evaluate investments, but they answer different questions:
NPV vs IRR Comparison
NPV (Net Present Value)
Answers: "How much money will I make (in today's dollars)?"
Use when: Comparing investments of different sizes
Weakness: Requires knowing the discount rate upfront
IRR (Internal Rate of Return)
Answers: "What % return will this investment give me?"
Use when: You want to know the percentage return
Weakness: Doesn't show absolute dollar gains
Key Takeaways on NPV
NPV shows whether an investment makes money after accounting for time value
The discount rate is your "required return" or "cost of capital"
NPV works for any investment: real estate, stocks, businesses, equipment
Understanding NPV helps you make smarter financial decisions
Practice Problem 1
You can invest $50,000 today and receive $15,000 for 4 years. At a 7% discount rate, what is the NPV?
Year 1: $15,000 ÷ 1.07 = $14,019
Year 2: $15,000 ÷ 1.07² = $13,100
Year 3: $15,000 ÷ 1.07³ = $12,243
Year 4: $15,000 ÷ 1.07⁴ = $11,439
Sum: $50,801 − $50,000 = NPV = +$801
Practice Problem 2
An investment requires $100,000 today and returns $25,000/year for 5 years. If your discount rate is 8%, calculate NPV.
Sum of discounted cash flows: $25,000 × [(1−1/(1.08)⁵)/0.08] = $99,818
NPV = $99,818 − $100,000 = NPV = −$182
Slightly negative—probably not worth it.
Practice Problem 3
You're evaluating a business investment: $200,000 upfront, then $60,000 profit/year for 4 years, plus $50,000 salvage value in year 4. Discount rate = 10%. Is it worth it?