Question

Mary has just been asked to analyze an investment to determine if it is acceptable. Unfortunately, she is not being given sufficient time to analyze the project using various methods. She must select one method of analysis and provide an answer based solely on that method. Which method do you suggest she use in this situation? Internal rate of return Payback Liquidity method Net present value Profitability index

Answer 1

Answer:

Mary should choose the Net Present Value method

Explanation:

The Net Present Value Method (NPV) takes into account the time value of money, i.e, recognises that cash-flows that are received sooner are worth more than cash-flows that are received in later years, and this method does this by discounting the expected cash-flows using the projects cost of capital.  It therefore takes into consideration the cost of capital and the risk inherent in making projections about the future unlike the Payback method

The NPV method also tells us in dollars terms, if the investment is profitable or not, and by how much. Therefore, using this method, it is very easy to rank different projects in terms of profitability and to choose between competing investments . The results are also not distorted in situations where the investments being analysed have more that one cash out-flow during the investment period as would happen with the Internal rate of return which can give multiple solutions.  This also makes the NPV   superior to the Profitability index where different investments can have the same index but are vastly different in terms of absolute dollar profitability.