Recently, the owner of our apartment told us they were thinking of selling and asked if we would consider buying it. We have lived here for almost two years and made it our home, so naturally, the question stayed in my head.
At first, I thought about it simply as buying a home. We already pay quite a high rent every month. If we owned the apartment instead, we could live in it ourselves and, if we moved somewhere else in the future, rent it out.
I guess that was when my finance brain started processing.
Suppose we bought the apartment, lived in it for a while, then rented it out for the next ten years. Every month, rental income would come in. Perhaps the value of the property would increase too, and eventually we could sell it for more than we paid.
On the surface, it looks like a successful investment.
We bought an asset.
It generated income.
We eventually sold it at a gain.
We made money.
But then I realised that this still wouldn’t tell me whether buying the apartment had actually been a good investment.
Because to generate those returns, we first had to commit a significant amount of capital. And if we were going to commit that capital to this property for the next ten years, there was a return we should reasonably expect it to generate.
So the question was no longer simply:
Will this apartment make money?
There was another question underneath it.
Will it make enough to justify the capital we have committed to it?
Will my investment make money?
If I were seriously considering buying the apartment as an investment, I would want to estimate how much rent it could realistically generate, how often it might sit vacant, what it would cost to maintain and what the property might eventually be worth.
Suppose those forecasts look good. The rental income covers the ongoing costs and leaves us with positive cash flows. After ten years, we expect to sell the apartment for more than we originally paid.
Based on what we know today, it looks profitable.
But an investment is still an investment.
We are committing capital today based on what we think will happen in the future.
We can estimate the rent, the costs and the eventual selling price, but we cannot know any of them with certainty.
NPV cannot tell us what will happen.
What it can do is help us decide whether, based on what we know today, the return we expect is enough to justify the capital we are committing.
An investment can make money and still leave that question unanswered.
What does NPV really ask?
This is where NPV quietly changes the question.
NPV, or net present value, takes the future cash flows we expect an investment to generate and discounts them back to what they are worth today.
The part I found harder to understand wasn’t the calculation.
It was why we discount those cash flows in the first place.
At first, inflation seemed like the obvious answer. Money loses purchasing power over time, so naturally €100 in the future should be worth less than €100 today.
But that doesn’t fully explain what NPV is doing.
Because if I invest €100 today, I don’t just expect to preserve the value of that €100.
I expect that capital to earn a return.
That changed how I understood discounting.
The future cash flows aren’t discounted simply because they happen later. They’re discounted because the capital we committed has a required return. Bringing those future cash flows back to today’s value allows us to compare what we expect to receive with what we have to give up today.
This is where NPV becomes much more interesting.
Every investment has a hurdle to clear.
If the present value of what I expect to receive is greater than what I have to invest today, the investment has cleared that hurdle and the NPV is positive.
If they’re equal, the NPV is zero.
If it’s lower, the NPV is negative.
The calculation itself is simple.
What matters is what that result is telling us.
Positive NPV: the investment is expected to meet the required return and create value above it.
Zero NPV: the investment is expected to earn exactly the required return.
Negative NPV: the investment is not expected to generate enough to meet the required return.
That last one changed the way I thought about profitability.
A negative NPV does not necessarily mean the investment makes no money.
Our apartment could generate rental income every month. We could eventually sell it for more than we originally paid. Looking only at the money coming in, we might reasonably say the investment had made money.
And yet, it could still have a negative NPV.
There is no contradiction.
It made money. It just didn’t make enough to justify the return required on the capital invested.
NPV takes account of the cost we don’t see
I think this is partly why profitability feels so persuasive.
We can see revenue.
We can see expenses.
We can see rent arriving in the bank account.
We can see the profit at the bottom of a P&L.
Opportunity cost is much harder to see.
There is no line on the income statement showing us the return from the investment we never made.
There is no invoice for leaving capital tied up for ten years.
There is no bank transaction labelled the opportunity you gave up.
But economically, it still matters.
The capital we put into one investment is capital we cannot put somewhere else.
We can see the return our investment generates but we cannot see so easily the return that same capital could have generated elsewhere.
Profit is visible. The return we gave up isn’t.
This is why the apartment question now looks slightly different to me.
If we bought it and eventually rented it out, seeing rental income arrive every month would tell me the property was generating money. Selling it one day for more than we paid would feel like another obvious sign that the investment had worked.
But neither, by itself, would tell me whether committing our capital to the property had been worth it.
For that, I would need to know what return I required from that capital in the first place.
And even then, I would still be making the decision without knowing exactly what the next ten years would bring.
The calculation is only ever as good as the expectations behind it.
Maybe profitability isn’t the final question
This is what I find increasingly interesting about finance.
Sometimes the calculation itself isn’t the most useful thing it teaches us.
It’s the question hiding underneath it.
NPV asks:
After accounting for the return required on the capital we committed, have we actually created value?
For a business whose objective is to increase shareholder wealth, that distinction matters.
Capital is limited.
Putting it into one investment means not putting it somewhere else.
And because investment always involves expectations about a future we cannot know with certainty, there will never be a calculation that makes the decision completely safe.
We still have to decide.
NPV doesn’t remove uncertainty. It simply helps us make a better decision in spite of it.
Making money tells us that something worked.
NPV asks whether it was worth what we put into it.
