Question

Briefly explain why NPV is better than the other 6 investment criteria.

Answer 1

NPV is better than other 6 investment criteria such as IRR,Payback period ,ARR etc because of the following reasons:-

(1)Considers all cash flows:- NPV uses all cash flows while other investment appraisal methods like payback period does not consider cash flows beyond pay back period.

(2)NPV relates projects with shareholders wealth:-The ultimate aim of every business or project is maximization of shareholders wealth and this method tells us how much value the proposed project is going to add in shareholders wealth while other methods does not focus on that.

(3)Considers time value of money:It discounts all cash flows properly while other methods like Pay back period does not consider time value of money .

(4)Better than IRR:- It is better than next best alternative IRR because IRR is the solution of polynomials therefore there can be multiple IRR which makes it difficult to interpret.