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Explain in detail and support your argument Make distinctions between the net present value (NPV) and...

Explain in detail and support your argument

Make distinctions between the net present value (NPV) and the profitability (PI) method in the capital budgeting analysis.

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Expert Solution

ANS: Net present value (NPV) is the difference between the present value of cash inflow & the present value of cash outflow over a required periof of time. NPV with a positive value shall be considered for accepting the project while Negative NPV were to be declined as the project won't be profitable in long run. NPV is used in th capital budgeting & investment planning to analyse the profitability of the project.

Profitability Index is calculated by dividing the present value of future cash flow by the Initail cost of the project. It is a tool which helps to analyse whether project should be accepted or not. PI greater than 1 indicates that present value of cash inflow is more than the Inital cash outlay & hence it will earn profit.

Distinctions between the net present value (NPV) and the profitability (PI) are -

  1. NPV is the present value of all future cash flows whereas PI is the ratio of preent value of furure cash flow divided by the initail investment.
  2. NPV is calculated as (Present value of cash Inflow - Present value of Cash outflow) with discounted rate whereas PI is the Present value of future cash flow / Initial Investment.

jeff jeffy answered 2 years ago
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