Question

You have been hired by the AutoEdge board of directors to assist them decide whether to stay in South Korea or return to the United States. As part of your analysis, Lester has asked you to conduct a net present value analysis. What are the limitations of net present value?

Answer 1

Answer:

.Requires estimation of future cash-flows and the appropriate discount rate

.Does not take into account qualitative factors

.Difficult to apply when comparing projects with differing lifespans

Explanation:

The net present value is the sum of the present values of all expected cash-flows less the initial outlay. Limitations of this method are that one has to estimate future cash-flows and the company's cost of capital to use when discounting these cash-flows. In this case, as part of net present value analysis, the analyst would have to estimate the cash-flows  and the applicable discount rate for each scenario, i.e if the company stays in South Korea or returns to the United States. Making a decision based on these projections may lead to a sub-optimal decision if incorrect information is used. The method also does not take into account other qualitative factors which may not necessarily be reflected in the expected cash-flows e.g the possibility of losing key employees if the company relocates.  It is also difficult to apply when comparing projects with differing lifespans.