Define net present value (NPV).

Define net present value (NPV).

• A. NPV is the sum of future cash inflows without discounting
• B. PV of cash inflows minus PV of cash outflows; accept project if NPV > 0
• C. NPV is the total of cash inflows
• D. NPV equals the future value of cash inflows minus outflows discounted at the risk-free rate

Answer: (B)

The main idea is that money has a time value. Net present value measures whether a project creates value by comparing the present value of all cash inflows to the present value of all cash outflows, using a discount rate that reflects the cost of capital and risk. The result is a single number: inflows PV minus outflows PV. If that number is positive, the project adds value and is typically accepted; if negative, it should be rejected. This is why the correct description is the present value of cash inflows minus the present value of cash outflows, with the rule to accept if the NPV is greater than zero. It accounts for when cash flows occur and the cost of capital to retrieve them. Avoiding discounting or mixing in future values leads to incorrect definitions. Simply summing inflows ignores the timing of those cash flows and the outflows. Focusing only on inflows misses the costs. Using the future value and discounting at the risk-free rate misstates both the present-value nature of NPV and the appropriate required return that reflects risk and opportunity cost.

The main idea is that money has a time value. Net present value measures whether a project creates value by comparing the present value of all cash inflows to the present value of all cash outflows, using a discount rate that reflects the cost of capital and risk. The result is a single number: inflows PV minus outflows PV. If that number is positive, the project adds value and is typically accepted; if negative, it should be rejected.

This is why the correct description is the present value of cash inflows minus the present value of cash outflows, with the rule to accept if the NPV is greater than zero. It accounts for when cash flows occur and the cost of capital to retrieve them.

Avoiding discounting or mixing in future values leads to incorrect definitions. Simply summing inflows ignores the timing of those cash flows and the outflows. Focusing only on inflows misses the costs. Using the future value and discounting at the risk-free rate misstates both the present-value nature of NPV and the appropriate required return that reflects risk and opportunity cost.