Explore BrainMass

Explore BrainMass

    Net Present Value

    Not what you're looking for? Search our solutions OR ask your own Custom question.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    "Smart analysts can massage the numbers in NPV analysis to make any project's NPV look positive. It is better to use a simpler approach, such as payback, that gives analysts fewer degrees of freedom to manipulate the numbers." Respond to this comment.

    © BrainMass Inc. brainmass.com December 24, 2021, 9:54 pm ad1c9bdddf
    https://brainmass.com/business/net-present-value/net-present-value-422911

    SOLUTION This solution is FREE courtesy of BrainMass!

    Please refer to the attached file for the response.

    NET PRESENT VALUE AND PAYBACK PERIOD: CAPITAL BUDGETING TOOLS

    "Smart analysts can massage the numbers in NPV analysis to make any project's NPV look positive. It is better to use a simpler approach, such as payback, that gives analysts fewer degrees of freedom to manipulate the numbers."

    A REACTION

    The net present value method depends much on the estimates of future cash flows for a project. The financial analyst will make use of assumptions of possible future events in estimating possible future cash flows. Another factor that will be assumed is the discount rate that will be used in computing the present value of the future cash flows. The discount rate may be the cost of capital or a cut-off rate (ROI) set by the management. Hence, the net present value analysis would depend much on the accuracy of the estimates made as well as the discount rate utilized. The issue therefore is not actually massaging the numbers in order to have positive net present values. It is more on varying the assumptions on future events that will affect the estimates of future cash flows.

    As compared to payback period, the net present value method is better because it takes into account the time value of money. The future cash flows are discounted to the present and compared to the initial outlay to determine whether proposed investment will be accepted. Just like the net present value method, the payback method also depends much on the estimates of future cash flows in determining the number of years before an initial investment will be recovered.
    The two methods measure different things : the payback measures the number of years before an investment is recovered while the net present value method measures the project's profitability, particularly the adequacy of the future cash flows ( when discounted to the present) to offset the initial outlay.

    REFERENCE:
    Keown, Arthur J., et al. (2002). Financial Management: Principles and Applications
    Pearson, Education, Inc.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    © BrainMass Inc. brainmass.com December 24, 2021, 9:54 pm ad1c9bdddf>
    https://brainmass.com/business/net-present-value/net-present-value-422911

    Attachments

    ADVERTISEMENT