net present value
Net Present Value tells you what a future stream of money is worth today, after accounting for the fact that money now beats money later.
In plain English
Chidinma runs a small poultry business in Ogun State, and a supplier offers her a deal: pay ₦2,000,000 now to install a new feeding system, and it will save her ₦500,000 a year for the next six years.
Her brother in Leeds hears this and says it sounds brilliant, six times five hundred thousand is three million, that is a million naira profit. But Chidinma pauses, because she knows that ₦500,000 landing in her account three years from now is not the same as ₦500,000 sitting in her hand today.
Money today can be invested, it can grow, it can be used to seize another opportunity, or it simply loses value slower than money you are promised later, especially with inflation eating at it along the way. Net Present Value is the tool that adjusts every one of those future ₦500,000 instalments backwards to what they are truly worth in today's terms, then adds them all up and subtracts the ₦2,000,000 she must pay now.
If that final number is positive, the feeding system is worth buying. If it is negative, she is better off keeping her ₦2,000,000 and finding something else to do with it. This is exactly the same thinking a company in the United Kingdom uses when deciding whether to open a new factory, or a Nigerian in Manchester uses when considering whether sending a lump sum home to start a small transport business will actually beat leaving the money in a savings account.
Net Present Value does not care about your gut feeling or how exciting the project sounds. It simply asks, once you discount every future naira back to today's value, does this thing still make sense.
Chidinma discounts her six years of ₦500,000 savings using a rate of 15%, which reflects what she could otherwise earn on her money. The discounted total comes to roughly ₦1,890,000. Since she must spend ₦2,000,000 today, her Net Present Value is about negative ₦110,000, so the feeding system, despite looking profitable on paper, is not quite worth it at that price.
Questions people ask
Why more than add up all the future savings without discounting them?
Because that ignores the cost of waiting. Money received later has less value than money received now, since you lose the chance to invest it, spend it, or protect it from inflation in the meantime. Discounting corrects for that lost time.
What discount rate should I use in my own calculations?
A common approach is to use the return you could reasonably earn elsewhere with similar risk, such as a fixed deposit rate, a business loan rate, or your cost of borrowing. There is no single correct number, it depends on your own alternatives and how risky the project is.
Can Net Present Value be positive but the project still fail?
Yes, because Net Present Value is only as good as the estimates that feed it. If your future savings or income figures turn out too optimistic, or costs run higher than planned, a project that looked good on paper can still disappoint in real life.
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