NPV vs ROI
The Net Present Value (or NPV) is an investment term that represents the difference between the present (and/or discounted) value of cash flow in the future and the present value of the investment and any cash flow that may accumulate in the future. Basically, it represents the net result of a multiyear investment (expressed in USD).
The Return on Investment (or the ROI) is an equation that measures the efficiency of an investment. Basically, it’s the quotient of the difference between the gain from an investment and the cost of investment, and the cost of investment:
(Gain from an investment-Cost of the Investment)/Cost of the Investment
As regards to the NPV, one must consider that this value is not used to ascertain levels of investment. It is simply a number by which the investor is aware of the amount of cash flow that he is receiving as a result of investment. It is also used to measure (or predict) the amount of cash flow that is to come in the future; it does not look at profits and losses in a traditional sense, as it takes into consideration the discount percentage.
As regards the ROI, one must consider that it has no real merit when trying to calculate future cash flow based on the cash flow that an investment is accumulating today. It is simply a way to measure the amount of profit (or return) an investment is making over time. However, it is a great indicator of where your investment stands –because of its simplicity and versatility it is one of the most commonly used values to measure the success of an investment. If an investment returns a negative ROI or there are more lucrative opportunities using a different ROI all together, then the investment should not be considered at all.
Both values do have their downsides, however. In terms of the NPV, this value does consider the discount rate of the dollar value at present and in the future; however, it doesn’t exactly calculate the initial investment that must be dedicated. If two investments have an NPV of $100, it may seem as if both were lucrative; however, if one has requires a dedicated investment of $10,000 and the other $1,000,000 it’s obvious the former is a much more promising investment. On the other hand, because the ROI is such a simple equation and is easily manipulated, the problem occurs when inputting the investment information.
Summary:
1. NPV measures the cash flow of an investment; ROI measures the efficiency of an investment.
2. NPV calculates future cash flow; ROI simply calculates the return that the investment produces.
3. NPV cannot determine the dedicated investment; ROI can be easily manipulated to the point of inaccuracy.