Definition of Present Value (PV)
Present value or PV is the result of discounting one or more future amounts to the present. The greater the discount rate, the smaller the present value.
Examples of Present Value
A cash amount of $10,000 received at the end of 5 years will have a present value (PV) of $6,210 when the $10,000 is discounted at 10% compounded annually. If the $10,000 is discounted at 12% compounded annually, the present value will be $5,670.
Definition of Net Present Value (NPV)
Net present value is the result of discounting all of the cash inflows and outflows and then combining all of their present values. This means that the original outflow (often the investment made at the present time) is a deduction from the other present values.
A positive net present value indicates that an investment is earning more than the discount rate. A negative net present value indicates an investment is earning less than the discount rate, but may be earning a positive rate. For example, if the cash flows are discounted by 12%, a slightly negative NPV could mean that the investment is earning 11%.
Examples of Net Present Value
Assume that an investment of $5,000 today will result in one cash receipt of $10,000 at the end of 5 years. If the investor requires a 10% annual return compounded annually, the net present value (NPV) of the investment is $1,210. This is the result of combining the present value of the cash inflow $6,210 (from the example above) and the $5,000 (which is the present of the $5,000 paid today).
Assuming the same information, except that the rate for discounting the cash amounts is 12%, the net present value (NPV) is $670. This is the $5,670 present value of the cash inflow combined with the present value of the $5,000 cash outflow.
