What is Net Present Value (NPV) and how is it interpreted?

• A. NPV is the discount rate that makes the sum zero.
• B. The net present value is the sum of discounted cash flows minus the initial investment; a positive NPV indicates value creation.
• C. NPV ignores the time value of money.
• D. NPV equals net income in the current period.

Answer: (B)

Net present value measures the profitability of an investment by discounting expected future cash flows back to their value today and comparing that total to the initial outlay. The key interpretation is that a positive NPV means the project earns more than the required return (cost of capital) and creates value for the firm; a zero NPV means it just covers the hurdle rate; a negative NPV means it fails to meet the required return and would destroy value. This hinges on the time value of money, since each future cash flow is discounted to reflect that money now is worth more than money later. A common way to express it is NPV = sum of (CF_t / (1 + r)^t) across periods t, minus the initial investment. This differs from the discount rate that makes the sum zero (the internal rate of return), does not ignore time value, and is not simply equal to net income, which is an accounting measure for a single period.