Question

How to simplify the computation of Net Present Value to non-accounting audience?

Answer 1

Net Present Value or NPV is mainly based on the concept of Time Value of Money. By which one can understand that Money worth today is not the same as Money worth a year or two ahead.

For instance why do banks give us interest for money kept with them?, so as to compensate us for the money's worth.

Due to inflation, changing economic conditions etc. things bought today are assumed to be having higher value than things bought later for the same amount. As cost of living increases purchasing power of money decreases.

In other words if a pencil can be brought for $1 today, same might come for $1.5 a year after or for $2 two years ahead. Thus what will be bought in $2 after two years can be bought for $1 today. Or, $2 two years ahead is only equal to $1 today. So, instead of getting $2 after two years one might prefer getting $1 today.

This is why under NPV method all the cash flows for a project are brought to their Present Values as per concept of Time Value of money and only thereupon Cash Inflows are compared to cash outflows (i.e. as on time 0). And if Cash Inflows are more than cash outflows after this discounting, a project can be considered beneficial.