Discuss characteristics of NPV and the role it plays in capital investment decision making.
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Examine and discuss the characteristics of NPV and the role that this method plays in capital investment decision making. In addition, discuss the advantages of using this method instead of the other evaluation methods: accounting rate of return (ARR), payback period (PP) and internal rate of return (IRR).
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The solution discusses the characteristics of NPV and role in capital investment decision making and its advantages over ARR, payback period and IRR in 527 words.
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Capital investment decisions are decisions that have a long time frame and we need to make the accept reject decisions for which projects should be selected. The Net Present Value (NPV) method provides yardstick for making the decision. We make capital investment decisions in the hope of getting more than what is invested and a project would be a good project if it returns more than the initial investment. Since the project is spread over many years, we also need to take into account the time value of money in making the decision. This is done by discounting the cash flows using the cost of capital as the discounting rate.
Thus we calculate NPV as Present Value of cash flows - initial investment. The cash flows are discounted to bring them to the present value and then the initial investment is subtracted. If the NPV is positive, this ...
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