Net Present Value (NPV): Formula & Calculation

Net Present Value (NPV): Complete Guide with Step-by-Step Examples

Net present value (NPV) is the difference between the present value of all future cash inflows and the cost of an investment, discounted at a required rate of return. If NPV is positive, the project creates value and should be accepted; if negative, it destroys value and should be rejected.

What Is Net Present Value (NPV)?

Net present value (NPV) is a capital budgeting technique that calculates the present value of all future cash inflows and outflows generated by an investment, discounted at the required rate of return, and nets them against the initial cost. A positive NPV means the project returns more than its cost of capital and creates shareholder value; a negative NPV means it destroys value.

NPV is the gold standard of investment appraisal because it accounts for the time value of money, the full life of the project, and the risk-adjusted cost of capital — all in a single number. Unlike payback period or accounting rate of return, NPV directly measures value creation in monetary terms.

“Net present value is the most direct measure of how much an investment adds to the value of the firm. It is the only criterion that always gives the correct accept-or-reject decision.” — Richard Brealey, Stewart Myers & Franklin Allen, Principles of Corporate Finance

NPV is used across investment banking, corporate finance, project appraisal, and professional certification exams including ACCA AFM, CFA, and CPA. In ACCA Advanced Financial Management, NPV-based questions appear in virtually every exam session and underpin the entire investment appraisal and business valuation syllabus.

The NPV Formula Explained

The NPV formula sums the present value of each year's net cash flow — discounted using (1+r)ⁿ — and subtracts the initial investment made at Year 0. The result is the net value created (or destroyed) by the investment in today's monetary terms.

How to Calculate NPV: Step-by-Step with Worked Example

Calculating NPV involves five steps: identify all cash flows, determine the discount rate, calculate the discount factor for each year, multiply each cash flow by its discount factor to get present value, and subtract the initial investment from the sum of all present values. Below is a fully worked domestic NPV example.

Worked Example — Project Apex:

Initial investment: $500,000 at Year 0. Discount rate (WACC): 10%. Project life: 4 years. Working capital required: $40,000 at Year 0, recovered in full at Year 4.

Decision: Accept the project. NPV = +$103,620. The project returns more than the 10% required rate of return and creates $103,620 of value above the cost of capital. The working capital of $40,000 is injected at Year 0 (no discounting needed) and recovered at Year 4 (discounted at 0.683) — note the recovery adds only $27,320 in present value terms, not $40,000.

NPV for Foreign Investments: Exchange Rate Forecasting

When evaluating a foreign investment project, future cash flows in the foreign currency must be converted to the home currency using forecast exchange rates — not today's spot rate. There are two valid approaches: the Home Currency Method (convert first, then discount) and the Foreign Currency Method (discount first, then convert). Both should give the same NPV result.

How to forecast exchange rates for NPV: Use Purchasing Power Parity (PPP) to derive expected future exchange rates based on relative inflation rates between the two countries:

Tax Credits, Losses Carried Forward & Working Capital Timing

Three of the most heavily tested NPV complications in ACCA AFM are: tax credits (which reduce the tax outflow in the year they are claimed), losses carried forward (which delay rather than eliminate the tax benefit), and working capital timing (where the injection and recovery must be placed in the correct year to score full marks). Getting the timing wrong on any of these changes the NPV materially.

1. Tax Credits vs Tax Losses Carried Forward

• Tax Credit: A direct reduction in the tax liability in the year it arises. If a project generates a $30,000 tax credit in Year 2, the tax payable in Year 2 is reduced by $30,000. This is an immediate cash benefit — include it as a positive cash flow in Year 2 of your NPV workings.
• Tax Loss Carried Forward: If a project makes a loss in Year 1, there is no immediate tax saving. The loss is carried forward and offsets taxable profits in the next profitable year (typically Year 2 in ACCA questions). The tax saving arrives one year later than students often assume — this timing error loses marks.
• Key Difference: Tax credits reduce tax now; carried-forward losses defer the tax benefit. In NPV terms, a Year 2 tax saving discounted at 10% is worth less than the same saving in Year 1. Always check: is this a credit (immediate) or a loss (deferred)?

2. Working Capital Timing

• Working capital is injected at the start of the period in which it is needed — typically Year 0 for the first year of trading, or Year 1 if the project starts mid-year.
• If working capital requirements increase in Year 2 (e.g. inventory builds), the incremental increase is a cash outflow in Year 1 (the start of Year 2's trading period).
• Working capital is fully recovered at the end of the project's last year. This recovery is a positive cash inflow and must be discounted back using the Year N discount factor — it is worth less than its face value.
• Never treat working capital recovery at face value. In the Project Apex example above, $40,000 recovered in Year 4 discounted at 10% = only $27,320 in present value terms.

NPV vs IRR: Which Should You Use?

NPV and Internal Rate of Return (IRR) are both discounted cash flow techniques but answer different questions. NPV measures the absolute value created by a project in monetary terms; IRR measures the percentage return. For most capital budgeting decisions, NPV is theoretically superior — but IRR is often preferred in practice because it is easier to communicate to non-finance stakeholders.

In ACCA AFM, you will often be asked to calculate both NPV and IRR and then advise on which is more appropriate. The standard answer is: NPV is theoretically superior because it measures absolute wealth creation, uses a more realistic reinvestment rate assumption, and always gives a correct accept/reject decision for mutually exclusive projects. For further reading on how NPV and free cash flow connect in valuation models, see our DCF Valuation: Complete Guide with Examples and our Free Cash Flow Formula, Calculation & Examples guides.

NPV in ACCA AFM: What Examiners Expect

In ACCA Advanced Financial Management, NPV is tested in both investment appraisal and business valuation contexts. The AFM examiner expects candidates to handle tax timing, inflation (nominal vs real), working capital movements, foreign currency adjustments, and Adjusted Present Value (APV) — all within a single exam question. Basic NPV mechanics are assumed; marks are earned on the advanced complications.

AFM candidates should also be comfortable with Adjusted Present Value (APV), which separates the base-case NPV (as if all-equity financed) from the present value of financing side effects (primarily the tax shield on debt). APV is preferred when the capital structure changes over the life of the project. For full preparation guidance, visit our ACCA AFM study materials and BPP online course, our guide to passing ACCA AFM, and the ACCA AFM technical articles 2026.

Frequently Asked Questions