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- Financial Ratios

### NPV - Net Present Value

For assessing the profitability of a financial plan, the most used quantities are the NPV and the IRR. The Net Present Value (NPV) is defined as the present value of the sum of the discounted cash-flows throughout the duration of the financial plan. This indicator represents the wealth created through the project, updated to the date of reference.

The **NPV** calculation is done through the application of the following mathematical formula:

where:

CF_{t} = expected cash flow in year t;

i = rate of interest used to discount the future cash flows;

n = number of years considered.

If the **NPV** is positive, the project is acceptable. The **IRR** (Internal Rate of Return) of the project is that rate at which the **NPV** is zero. The **IRR** therefore represents the maximum cost that the sponsors are available to incur to make the investment.

The definition of the appropriate discount rate to be applied is very complex: it should reflect the riskiness of the project and significantly affects the amount of **NPV**. Must also take into account the cash flow configuration that you use as an operating cash-flow must be discounted at a rate which reflects the weighted average cost of capital. In contrast, the net cash-flow will be discounted using a discount rate which refers to the Equity only.