Net present value (NPV) is a financial calculation used to determine the profitability of an investment. It’s calculated by discounting the future cash flows of the investment to determine its present value. Discounting future cash flows makes sense because a dollar today is considered more valuable than a dollar in the future due to inflation and the opportunity cost of not having that dollar available for other investments.
The discount rate is a crucial component of NPV calculation. It represents the minimum rate of return that investors require to invest in the project. A higher discount rate will result in a lower NPV, and vice versa. Understanding how to calculate NPV with a discount rate is a valuable skill for financial analysts and investors alike.