Net present value (NPV) is a financial metric used to assess the profitability of an investment by calculating the difference between the present value of cash inflows generated by the investment and the present value of cash outflows associated with it. This calculation takes into account the time value of money, recognizing that a dollar today is worth more than a dollar in the future due to its potential earning capacity.
When evaluating an investment, NPV allows decision-makers to determine whether the expected cash flows from the investment meet or exceed the cost of the investment when adjusted for time. A positive NPV indicates that the investment is expected to generate more wealth than it costs, making it a profitable endeavor. Conversely, a negative NPV suggests that the investment would result in a loss.
Thus, the primary purpose of calculating net present value is to evaluate the profitability of an investment, guiding stakeholders in making informed financial decisions regarding their projects.