The NPV (Net Present Value) calculation method is employed by businesses and project managers. It is used to evaluate the overall profitability of a project before starting it. This method is easy to implement, but it comes with its own pros and cons.
The main logic behind this idea is that the money you’ll receive in the future is worth less as compared to the money you currently own. So we apply this formula to find out the value of future cash according to today’s cash value.
By calculating things with the NPV method, we eventually end up with a number. This number tells us how much value a certain project can male for our company over time.
This method is also used by the stockholders of a company to calculate the value of projects. Based on the analysis, shareholders can determine if they want to invest in a project or not.
The biggest concern about the NPV method is that it included guesswork about the future. We can’t apply this method to compare two projects with different amount of investments.
Larger projects have a higher NPV as compared to smaller projects. But the larger ones require more investment as well, so, this doesn’t make any difference. That’s why companies usually prefer other methods of comparison as well.
This technique is also difficult to apply when you’re comparing two projects with differing lifespans. For example; it’ll be very difficult to compare the NPVs of two projects where one has a lifespan of 5 years and the other one has 20 years.
These were some of the pros and cons of the NPV method that you can apply in your business. Keep in mind it’s limitations and consider some alternatives as well before investing.