Final answer:
Subtracting the present value of the initial investment from the present value of cash flows generates the net present value (NPV), which is essential for evaluating investment profitability, factoring in potential capital gains, dividends, and risk.
Step-by-step explanation:
Subtracting the present value of the initial investment from the present value of cash flows generated by that investment, discounted at the required rate of return, results in the net present value (NPV). The concept of NPV is critical in finance as it allows investors and businesses to assess the profitability of an investment or project. It incorporates the time value of money by discounting future cash flows to their value in present terms using a discount rate. This discount rate takes into account potential capital gains, dividends, and the risk profile of the investment. In essence, NPV represents the value added or subtracted from an investment after considering the costs and discounted future benefits.