Concept of Time Value of Money (TVM):
Money now is more valuable than money later on. Why? Because you can use money to make more money! You could invest in a business venture, or put the money in the bank to earn interest. So $1,000 now is the same as $1,100 next year (at 10% interest).
Money in the present is worth more than the same amount in the future. This is both because of earnings that could potentially be made using the money during the intervening time and because of inflation. In other words, a dollar earned in the future won’t be worth as much as one earned now, in the present.
Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used to analyze the profitability of a projected investment or project.
By looking at all of the money you expect to make from the investment and translating those returns into today’s dollars, you can decide whether the project is worthwhile.
One primary issue with gauging an investment’s profitability with NPV is that NPV relies heavily upon multiple assumptions and estimates, so there can be substantial room for error. Estimated factors include investment costs, discount rate and projected returns. A project may often require unforeseen expenditures to get off the ground or may require additional expenditure at the project’s end.