In one sentenceThe total of a project's future cash flows discounted to their value today at a required rate of return, minus the project's cost.
Simply put
A riyal that comes to you in a year is worth less than a riyal today. So you divide each year's cash flow by (1 + discount rate) raised to the year number, then add up the results and deduct the cost.
If the result is positive, the project earns more than the return you required, and if it is negative, it earns less, even if it looks profitable in plain figures.
Worked example
A printing house is considering buying a machine for 100,000 SAR that generates a cash flow of 60,000 SAR in each of two years, and the required return is 10% a year.
Value of year one today = 60,000 ÷ 1.154,545.45 SAR
Value of year two today = 60,000 ÷ 1.2149,586.78 SAR
Total present values104,132.23 SAR
Net present value = 104,132.23 − 100,0004,132.23 SAR
Formula: Sum of (each year's cash flow ÷ (1 + discount rate)^year number) − initial cost
Don't confuse it with
Internal rate of returnNet present value is an amount in SAR at a rate you choose, and the internal rate of return is the rate that makes this amount zero.