Given that the net present value (NPV) is generally considered to be the best me

Question

Given that the net present value (NPV) is generally considered to be the best method of analysis, why could you still use the other methods?

You need to use other methods because the net present value method is unreliable when a project has unconventional cash flows.

You need to use the other methods since conventional practice dictates that you only accept projects after you have generated three accept indicators.

The other methods provide results that are generally easier to understand than a net present value analysis.

The average accounting return must always indicate acceptance since this is the best method from a financial perspective.

The discounted payback method must always be computed to determine if a project returns a positive cash flow since NPV does not measure this aspect of a project

Explanation / Answer

NPV is best capital budgeting technique. it compares present value of expected benefits and cash flow from a project to the present value of the expected cost. If benefits larger the project is accepted. Positive NPV increase share holder wealth and negative NPV decrease.

Accounting rate of return compute the return on a capital project's net income and book value rather than cash flow.. with this method true results not generated because it ignores the concept of time value of money and there is no such economic rational which maximizing share holder's wealth.

The other method are easy to understand than a NPV but it shows consideration of all cash flows, future cash flows using time value of money. It will give an exact picture of estimation.

Discounted payback period does not shows whether investment increase the firm's value or not, plus it requires estimation of cost of capital in order to calculate. It will also ignores cash flows beyond the discounted period.

If we are using payback period, it will not give concrete decision criteria to indicate whether an investment increases the firm's value or not. This method also ignores cash flow beyond the payback period, time value of money and Risk of future cash flow.

Internal Rate of return method requires an estimate of cost of capital in order to make a decision. It will not give value maximizing decision when used to compare or choose mutually exclusive projects. It will not more benefited in situation where sign of cashflow of a project change more than once during the project's life.

Related Questions

Navigate

• Browse (All)
• Browse G
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.