Question

An advantage of the net present value method for evaluating investment proposals over the

internal rate of return method is that:
A. only one set of present value calculations using a required discount rate is made.
B. the actual rate of return on the project is calculated.
C. projects can be ranked in order of profitability using the net present value amount.
D. estimates of future cash flows do not have to be made

Answer 1

The NPV method is advantageous over IRR as it ranks projects by profitability based on their net present value, aligning with the value creation goal of a company.

Step-by-step explanation:

The advantage of the net present value (NPV) method over the internal rate of return (IRR) method is that it allows projects to be ranked in order of profitability using the net present value amount. This is because NPV quantifies the absolute value an investment will generate under a specific discount rate, which aligns directly with the value creation objective of a company.

Estimates of future cash flows are necessary in both NPV and IRR methods, and both require presenting a set of cash flows in present value terms to evaluate the investment. However, unlike IRR, NPV can provide a scale of preference for competing projects, which is crucial for capital budgeting decisions.