Net Present Value: What Future Income Is Worth Today

Let’s talk about NPV. NPV is just the net present value of something. It’s when you say that stream of payments I’m gonna get in the future: what is that worth today?

So a common example of this is you're joining a startup company and you're getting stock options. The founder says, “Well, this company is going to be worth a billion dollars and I’m giving you 0.1 percent of the company; therefore, you’re getting a million dollars worth of stock.” What he’s or she’s arguing is what’s going to be worth in the future. You have to discount that back to today. You have to figure out what is that worth today, and you have to apply a discount rate or an interest rate that takes into account the massive risk the startups face.

What you end up with is the price that it’s worth today, and that’s the price at which a venture capitalist would invest in the company today. So if that founder just raised a round at ten million dollars and that company’s only worth one percent of what the founder's arguing, your million-dollar package is actually worth ten thousand dollars.

So NPV calculations, at a very rough level, you should be very comfortable doing in your head.