What is the definition of net present value (NPV)?

Net Present Value (NPV) is defined as the difference between the present value of cash inflows and the present value of cash outflows over a specified period. This financial metric is utilized to assess the profitability of an investment or project, as it takes into account the time value of money. By discounting future cash flows back to their present value, NPV allows for a comparison of the current cost of the investment against the anticipated future returns.

The essence of NPV is in its ability to determine whether an investment will add value to the firm. A positive NPV indicates that the investment is expected to generate more cash than it costs, thus signifying a potentially profitable opportunity. Conversely, a negative NPV suggests that the costs outweigh the benefits, leading to a recommendation against pursuing the investment.

In summary, the correct understanding of NPV focuses on the calculation of cash inflows and outflows, with an emphasis on their timing and value, which is why the assertion of it being the difference between these cash flows over time accurately reflects its purpose in business finance.