PV vs NPV (Present Value vs Net Present Value)

Difference Between PV and NPV

Present value (PV) refers to the present value of all future cash inflows in the
company during a particular period of time whereas net present value (NPV) is
the value derived by deducting the present value of all the cash outflows of the
company from the present value of the total Cash inflows of the company.
What is Present Value (PV)?

PV or Present Value is the sum of all future cash flows discounted at a specific
rate of return. Present value is also known as a discounted value, and it helps in
determining the fair value of future revenues or liability. The calculation of
present value is a very important concept in finance and is also used in calculating
the valuations of a company. This concept is also important in determining the
price of the bond, spot rates, value of annuities, and also for the calculation of
pension obligations. Calculating the present value helps in determining how
much do you need to fulfill a future goal like buying a house or paying tuition
fees. It also helps you calculate if you should buy a car on EMI or pay the
mortgage

The present value is calculated using the equation:

Present value = FV / (1 + r)n

where

• FV is the future value

• r is the required rate of return, and n is the number of periods.

The higher the rate, the lower the return. This is because the cash flows are
discounted at a higher rate
 We want to know the present value of $100 in one year, of which the discount
rate is 10%

• Present Value = 100/(1+10%)1 = $91

What is Net Present Value (NPV)?

NPV, or net present value, is the summation of all present values of a series of
payments and future cash flows. NPV provides a method for comparing products
that have cash flows spread across years. This concept can be used in loans,
payouts, investments, and many other applications. The net present value is the
difference between today’s expected cash flows and today’s value of cash
investment.
It is also an important concept in capital budgeting. It a complex and
comprehensive way to calculate and to understand if a project is financially
viable. This concept includes many other financial concepts like cash flows,
required return (weighted average cost of capital), terminal value, time value of
money, and salvage value
A positive present value means that the company is generating revenues more
than its expenses and making a profit. It is considered that if the company
estimates that a project has a positive net present value, then the project is
assumed to be profitable, and a project with negative cash flows is assumed to
be loss-making.
Net present value can be calculated using the formula.
 Where R1 = Net Cash flow in period one, R2 = Net Cash flow in period two, R3=
Net Cash flow in period three, and i = the discount rate

Assume that a company buys a machine for $1000, which generates cash flows
of $600 in year one, $550 in year two, $400 in year three, and $100 in year four.
Calculate the net present values assuming a discount rate of 15%

• NPV = [ $600/(1+15)1 + $550/(1+15)2 + $400/(1+15)3 + $100/(1+15)4 ] – $1000

• NPV = $257.8

Key Difference

• Present value or PV is the addition of all the future cash inflows given at a
particular rate. On the other hand, the Net present value is the difference between
the cash flows earned at the various period and the initial investment required to
finance
• Present value helps in making investment decisions for cars or to calculate the
value of the liabilities, investment decisions related to bonds, spot rates, etc. On
the other hand, the net present value is mainly used by companies in evaluating
capital budgeting decisions. An important point to note here is that it is assumed
that every project with a positive net present value is profitable. For a company
that has unlimited sources of cash, it can only make such decisions; such a
scenario is not possible in the real world. Projects with the highest NPV are
selected by a company along with using other metrics like IRR (internal rate of
return), PB (payback period), DPB (discounted payback period)
• The calculation of Present value is simply discounting the future cash flow by the
required rate of return for a required period. Net present value is, however, more
complex, and takes into account cash flows at different periods.
• Net present value helps in calculating profitability while the present value does
not help in calculating wealth creation or profitability.
• Net present value accounts for the initial investment required to calculate the net
figure while the present value only accounts for cash flow.
• It is very important to understand the concept of Present value; however, the
concept of net present value is more comprehensive and complex.

PV vs NPV Comparative Table

Basis Present Value Net Present Value

Present Value calculates the The net present value calculates

discounted cash flows of all how profitable a project is after
Definition
the revenues estimated to calculating the initial
generate in a project. investment required.

It measures the value of a

It measures the value of
Measure project. If the company should
future cash flows today.
undertake the project or not

The present value gives an

NPV calculates the additional
Wealth absolute number and does
wealth generated by calculating
Creation not measure the additional
the profitability of the project
wealth created.
 Basis Present Value Net Present Value

PV method is simple and

understood by the general Net present value is used

Acceptance public and can be used in mainly by business managers

their daily decision-making and helps in capital

process. budgeting decisions.

PV calculates the current

NPV knocks out cash inflow
value of Cash Inflow, which
Cash Flow with cash outflow for decision
is generated for a particular
making the purpose
period.

Conclusion

Present value is the stepping stone to understand the concept of net present value.
The application of both these concepts is very important in the decision-making
process for an individual and the company. However, other concepts, along with
these two, will help the investor or the business manager take more informed
decisions.