Question

1. Net Present Value (NPV) examines financial performance in absolute terms. How does this differ from Benefit/Cost Ratios and Internal Rate of Return (IRR)?
2. Net Present Value requires the computation of a discount rate. Discuss the challenges this presents to an organization.
3. What is the fundamental premise of Benefit/Cost Analysis? What is the value of this analysis? What are some of the risks?

Answer 1

NPV gives the value of the project in terms of money. The higher is the value of the project, the better is the peoject. IRR is the rate of return that the project will earn whereas the benefit cost ratio is a number that is obtained by dividing the value of the benefit with the cost.

To find out the Net Present Value, the company will have to decide the discounting rate. In order to find out the discounting rate, the company generally takes the cost of capital or the rate at which the company has taken loan from the bank.

The benefit cost analysis is the process of analyzing a project by computing the benefits that will be obtained from the project and the costs that are involved in it. The fundamental premise is that there should be more benefits from the project than the costs involved. If a project has more benefits than costs then it is considered to be a good project. The value of this analysis is in terms of ratio after dividing the costs and benefits. The risk involved is that there might be some wrong estimation in the costs involved or the benefits obtained.