Financial Metrics · Intermediate level · 4 min read ·
What is NPV (Net Present Value)?
NPV, net present value, turns all of a project's projected future cash flows into today's pesos, discounted at a chosen rate, and subtracts the initial contribution. If it is positive, the projected flows exceed what that rate requires; if negative, they fall short. Its result depends entirely on the rate used.
In 30 seconds
- A peso that arrives in the future is worth less than a peso today; NPV makes that adjustment.
- Positive NPV: the projected flows exceed what the discount rate requires.
- On solar sheets the rate used is the WACC, shown next to the figure.
Why should you care?
Adding up pesos from different years as if they were equal inflates any projection. NPV puts them all on the same date: today.
- You understand what "NPV (WACC x%)" means on a project sheet.
- You see that one projection can give a high or low NPV depending on the rate.
- You connect NPV with IRR: IRR is the rate at which NPV equals zero.
Think of it as fruit bought before the harvest
If someone offers you next year's harvest today, you don't pay what you would for fruit that's ready: you discount the wait and the uncertainty. NPV applies that discount to every future flow of a project.
How does NPV work?
- 1
List the projected flows
What the project is expected to deliver each year, according to its model.
- 2
Choose the discount rate
On solar sheets it is the WACC, the weighted average cost of capital: it blends the cost of debt and what contributors expect, weighted by each one's share.
- 3
Bring each flow to today
Divide each flow by (1 + rate) raised to the number of years until it arrives.
- 4
Add up and subtract the initial contribution
The result is NPV. Positive, zero or negative, it is always read with the rate that was used.
The formula
NPV = −C₀ + F₁ ÷ (1 + r)¹ + F₂ ÷ (1 + r)² + … + Fₙ ÷ (1 + r)ⁿ
- C₀
- = initial contribution
- Fₜ
- = projected flow in year t
- r
- = discount rate, for example the WACC
An example with numbers
As plain arithmetic, unrelated to any project: you contribute 180 units today, and 110 units are projected in year 1 and 121 in year 2. Illustrative discount rate: 10%.
| Year 1 in today's terms: 110 ÷ 1.1 | 100 |
|---|---|
| Year 2 in today's terms: 121 ÷ 1.21 | 100 |
| Sum of present values | 200 |
| Initial contribution | 180 |
| NPV at 10% | 20 |
Undiscounted, the flows add up to 231 and the surplus would look like 51. In today's pesos, at a 10% rate, it is 20. At a higher rate it would be smaller still.
Where do you see it at Circular Urban?
On solar project sheets, the Financial Models section shows each model's NPV with the rate used in brackets, "NPV (WACC x%)", next to IRR, payback and ROI. It is a non-binding reference projection: its flows are subject to the project's actual performance.
- Solar project sheets, in Financial Models: NPV (WACC x%).
What changes in your finances once you get it
You compare payments on different dates
A payment today and one in three years aren't worth the same, even for the same amount.
You weigh an instalment plan
You bring future instalments to today to see what a financed purchase really costs.
You always check the rate
For any figure "at present value", you ask which rate was used.
Common mistakes
- Myth
An NPV of 20 means I'll get back 20 more than I put in.
- In reality
NPV is the surplus in today's pesos, above what the rate requires. In nominal pesos, the flows received can add up to considerably more.
- Myth
NPV is a fixed figure for the project.
- In reality
It changes with the discount rate and with the projected flows. That is why the sheet states the WACC used.
- Myth
The WACC is a rate someone promises to pay.
- In reality
It is the weighted average cost of capital: a reference rate for discounting flows. For example, with 60% contributions expecting 15% and 40% debt at 10%, the simplified WACC is 0.6 × 15 + 0.4 × 10 = 13%.
Test yourself
You contribute 90 units today and are projected to receive 110 in one year. At a 10% discount rate, what is the NPV?
Keep learning
Helps to know first
What comes next
This content is educational. Every participation carries risks inherent to the project, including the possibility of partial or total loss, and results are subject to each project's actual performance.
