# What Does a Positive Net Present Value Mean When Appraising Long-Term Projects?

Small business owners frequently make decisions about how to invest money to increase profitability. Part of being a good business manager is the ability to analyze the income potential of long-term projects, to choose ones that have the greatest potential to increase profit. Net present value (NPV) is a financial tool that business analysts use to judge the viability of new projects.

## Net Present Value

Net present value is a numerical calculation that shows the present value of an investment based on expected income from that investment in future years minus the cost of the project. Net present value is calculated by dividing the expected income of a project in each future year by a term equal to one plus a discount rate raised to a power equal to the year. The totals for each year then are added together, and the initial cost of the project is subtracted from that sum to arrive at the net present value. The discount rate represents the time value of money: the amount that could be made by committing the money to other opportunities.

## Positive Net Present Value

The purpose of net present value is to help analysts and managers decide whether or not new projects are financially viable. Essentially, net present value measures the total amount of gain or loss a project will produce compared to the amount that could be earned simply by saving the money in a bank or investing it in some other opportunity that generates a return equal to the discount rate. If a long-term project has a positive net present value, then it is expected to produce more income than what could be gained by earning the discount rate, which means the company should go ahead with the project.

## Zero or Negative Net Present Value

If a certain project has a net present value of zero, then the company neither gains nor loses money by pursuing the project. When net present value is less than zero, the project is expected to lose money. Projects with a negative net present value should be avoided.

## Limitations of Net Present Value

Similar to other tools used to make conjectures about the future, net present value is limited by guesses about what might occur in the future. The usefulness of net present value relies entirely upon accuracy of the expected income of a project and the discount rate. If the discount rate is set too low or expected income is too optimistic, then net present value might reflect an overestimation of a project's potential.

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Writer Bio

Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.