1) Capital budgeting is the process of analyzing potential projects. What does net present value (NPV) represent in capital budgeting analysis? How does NPV compare to internal rate of return (IRR); specifically, what makes them similar and different? What functional flaw exists in the discounted payback period calculation that makes this capital budgeting tool suspect?
NPV represents the difference of the discounted value of future
cash flows and investment . NPV >0 represents a
favorable project whereas NPV < 0 represents a project that should be rejected. The discount rate is the projects return
IRR is the rate at which NPV = 0 . For mutually exclusive projects both give the same result however for independent projects NPV is better than IRR
? Functional flaw in the discounted payback period calculation is the cash flows after payback period is not considered and may lead to rejection of project of higher NPV whose cash flows increase after the payback period.
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