What does net present value (NPV) represent?

Net present value (NPV) is a financial metric that is used to evaluate the profitability of an investment or project by assessing the present value of its cash inflows compared to the present value of its cash outflows. It represents the difference between the present value of future cash inflows generated by the investment and the present value of the costs associated with that investment. By calculating the NPV, decision-makers can determine whether an investment is expected to yield a profit or a loss in today’s dollars, taking into account the time value of money.

If the NPV is positive, it indicates that the projected earnings (in present value terms) exceed the anticipated costs, suggesting that the investment would add value to the firm. A negative NPV means that the project would subtract value, while an NPV of zero suggests that the project would break even. Therefore, understanding NPV is crucial for informed decision-making regarding project selection and capital budgeting.

In contrast, total revenue generated from investments simply reflects the gross monetary gains without accounting for the timing and magnitude of costs, while overall profitability and measures of liabilities versus assets focus on broader financial health and stability rather than the specific cash flow analysis provided by NPV.