Net Present Value

NPV refers to the value today of all expected future cash flows minus the value today of any investments required to generate the expected future cash flows.

It is a measure of the economic value of the project.

This is based on the assumption that projects with positive NPVs increase company value.

N P V_{P R O J E C T} = \sum_{t = 1}^{T} \frac{C F_{t}}{(1 + r)^{t}} - Initial Investment (t = 0)

$C F_{t}$ - expected future cash flows (future benefits)
$r$ - discount rate or interest rate
Initial Investment - what is paid to get future benefits

A company’s market value should come from the value of the firm’s projects. A company’s cash flows come from the firm’s projects. NPV measures the present value of cash flows from firm projects.

Accepting positive NPV projects should increase the value of the firm. Negative NPV projects should decrease the value of the firm.

A company’s market value is what investors are willing to pay for the company. Company’s market value should increase when company managers invest in positive NPV project.

However, a company’s market value may not increase even when company managers invest in positive NPV project if investors:

Do not know the company has invested in positive NPV projects
Have difficulty understanding the project, such as uncertainties in future cash flows
Do not believe the company's managers statements about the positive NPV projects the company undertakes