Why is the NPV method considered by finance specialists to be the best method for capital...

Why is the NPV method considered by finance specialists to be the best method for capital budgeting? What does the NPV of a project tell managers?

Expert Solution

NPV is Net Present Value. It is the excess of present value of cash inflows over present value of cash outflows.

NPV = Present value of cash inflows - Present value of cash outflows

NPV method is considered to be the best method for capital budgeting since it helps in evaluating projects in absolute dollar terms. It tells the amount of dollars a project is able to generate above the cost of that project. NPV method assumes that the cash flows generated are reinvested at the required rate of return. It also takes into consideration time value of money and hence due to all these positives is considered the best method by finance specialist.

NPV of a project tells a manager whether the project is able to generate sufficient cash flows to cover its cost and also earn profits. If NPV is positive, the project should be accepted. If the NPV is negative, the project should be rejected since it is not profitable.

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