Question

NPV and capital budgeting

COLLAPSE

Do you think that the NPV should be used for all the capital budgeting cases? Explain.

Answer 1

Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time

NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project

Net present value (NPV) is a method used to determine the current value of all future cash flows generated by a project, including the initial capital investment. It is widely used in capital budgeting to establish which projects are likely to turn the greatest profit.

NPV method uses a reinvestment rate close to its current cost of capital, the reinvestment assumptions of the NPV method are more realistic than those associated with the IRR method. ... In conclusion, NPV is a better method for evaluating mutually exclusive projects than the IRR method

NO IN ALL CASES NPV SHOULD NOT BE USED FOR ALL CAPITAL BUDGETING CASES

NPV CAN NOT BE USED IN THE FOLLOWING CASES

1. Where Matter is more complex is the possibility that the investment will not have the same level of risk throughout its entire time horizon.

2. NPV is limited in that it only takes into consideration the cash flows of a project. It fails to include other critical costs that can have an impact on the true value of the investment so where Additional Cost is incurred NPV is not Proper Measure

3. A higher NPV doesn't necessarily mean a better investment. If there are two investments or projects up for decision, and one project is larger in scale, the NPV will be higher for that project as NPV is reported in dollars and a larger outlay will result in a larger number. It's important to assess the returns from an investment in percentage terms to get an accurate picture of which investment provides a better return