What does the Net Present Value (NPV) formula calculate?

The Net Present Value (NPV) formula is designed to assess the profitability of an investment by comparing the present value of cash inflows to the present value of cash outflows. It does this by calculating the difference between the two, which is represented mathematically as PV(cash inflow) - PV(cash outflow).

By calculating NPV in this way, one can determine whether an investment will generate more cash than it costs and, therefore, whether it creates value for the investor. A positive NPV indicates that the projected earnings, discounted for their present value, exceed the anticipated costs, also discounted to present value—signifying a potentially worthwhile investment. Conversely, a negative NPV suggests that the costs outweigh the benefits.

The other options do not correctly reflect the fundamental principle of NPV. They either combine the cash flows inappropriately or suggest a division that does not align with the intention of assessing investment profitability. Therefore, the correct answer effectively captures the essence of what NPV aims to calculate: the net value generated from an investment after accounting for its initial costs.