Net Present Value

Today I impart the most important takeaway ever from Finance or Financial Management.  Always do a project if the Net Present Value is positive. It represents the culmination of a project cost calculation that includes the time value of money and the likelihood of different outcomes, and spits out a value for the project that you can use to objectively compare it to other projects (if you have limited funds).

Net Present Value (NPV) is a financial calculation used to determine whether to pursue a project.  NPV takes into account everything (if possible) about the project.  You need to quantify reward and financial outlay, of course.  But you also need to consider the risk of a project not meeting your projections.  In a simplified example, if you have a 50% chance to win $1 million and a 50% chance to lose $1 million, rationally, the chance would be worth exactly $0.   That evaluation needs to be done with a person's risk tolerance in mind, too.  While rationally that chance is worth nothing, a someone with a high risk tolerance may believe that the possible reward is worth the possible loss.

All financial projections have flaws.  I learned about several of them.  But the model with the LEAST flaws is NPV.  This calculation is the way a numbers-oriented manager chooses new projects.  There are underlying assumptions that must be stated when doing the calculation, but if you only make conservative assumptions, the calculation is defensible and persuasive.