Question

Which of the following are advantages of using net present value when evaluating projects?

I. NPV lets you know in today's dollars how much better off or worse off you will be if you accept a project.
II. NPV includes time value of money considerations.
III. The NPV method quickly determines the discount rate that changes an accept decision into a reject decision and vice versa.
IV. NPV indicates the expected impact on the owners of the firm.
A) I and II only
B) II and IV only
C) I, II, and IV only
D) II, III, and IV only
E) I, II, III, and IV

Answer 1

Net present value (NPV) is advantageous because it includes the time value of money, shows profitability in today's dollars, and indicates the expected impact on firm owners, but does not determine the discount rate that changes an accept/reject decision.

Step-by-step explanation:

The advantages of using net present value (NPV) when evaluating projects include:

• Time value of money considerations – NPV accounts for the fact that money available now is worth more than the same amount in the future due to its potential earning capacity.
• Measure of profitability in today's dollars – NPV indicates how much better off or worse off a company will be in today's dollars if a project is accepted.
• Impact on firm owners – NPV shows the expected impact of a project on the owners of the firm, as it represents the value added or subtracted from the firm's value.

However, NPV does not indicate the discount rate that changes an accept decision into a reject decision; this is the role of the Internal Rate of Return (IRR).