A4.6 Net Present Value (NPV) is the name given to the sum of the discounted benefits of an option less the sum of its discounted costs, all discounted to the same base date. Its significance as a key summary indicator of the comparative value of an option is explained in section 2.8 of the Option Appraisal Guide. A negative NPV is generally referred to as a Net Present Cost (NPC).
Example: Equipment with 4 years of life requires replacement. There are two options A and B with different capital and recurrent costs. No monetary benefits are identifiable. The aim is simply to choose the least cost solution i.e. that with the lower NPC.
Year | 0 | 1 | 2 | 3 | 4 | |
Discount Factor | 1 | 0.9662 | 0.9335 | 0.9019 | 0.8714 |
|
Option A | £k | £k | £k | £k | £k | £k |
Capital Costs | 100 |
|
|
|
|
|
Revenue Costs |
| 35 | 35 | 35 | 35 |
|
Present Value | 100 | 33.8 | 32.7 | 31.6 | 30.5 | 228.6 |
Option B |
|
|
|
|
|
|
Capital Costs | 75 |
|
|
|
|
|
Revenue Costs |
| 47 | 47 | 47 | 47 |
|
Present Value | 75 | 45.4 | 43.9 | 42.4 | 41.0 | 247.7 |
Despite higher capital costs initially, Option A has the lower net present cost and should be preferred to Option B.