Project viability assessment through Net Present Value (NPV)

Abstract

The Net Present Value (NPV) is a widely used financial metric in project management. Its purpose is to evaluate the profitability of a proposed project by aggregating the streams of costs and benefits into a single value. This makes for an effective indicator of identifying profitable projects when assessing multiple projects at a time. For a given project to be considered a profitable investment, its NPV must be larger than zero.

Central to the calculation of the NPV is assigning varying weights, dependent on time, to the benefits and costs through the utilization of a so-called discount factor, which is calculated using a discount rate. The discount rate represents the rate of interest that is used to discount all future costs and benefits. By incorporating this principle, the NPV accounts for and subscribes to the paradigm of the time value of money, referring to the idea that money has a different value at different points in time.

This article explores central concepts connected to the calculation and application of NPV in the assessment of projects, programs, or portfolios. For demonstration purposes, an example of the calculation of an emulated project's NPV will be given. Moreover, the advantages and disadvantages of using NPV as an indicator of project profitability will be addressed.

NPV Formula

The net present value method or tool achieves comparability of all costs and benefits by discounting to the beginning of the investment period. The NPV is amongst the most frequent and sophisticated tools when it comes to assessing the probability of projects or investments.

Gardner, N.D. 2004. The Time Value of Money: A Clarifying and Simplifying Approach. Journal of College Teaching & Learning (TLC). 1, 7 (Jul. 2004).