Why Npv Is The Best Investment Appraisal?

Question

Why Npv Is The Best Investment Appraisal?

2 Answers

Answer Question

Answer 1

I don't think that NPV is best Investment appraisal method, but it is better than others.
Because it takes into account the time value of money and considers the cash flows stream in its entirety. It squares clearly with the financial objective of maximisation of the shareholders' wealth.
These are some reasons that make NPV is better than others.

Answer 2

NPV uses cash flows. Cash flows from a project can be used for a number of corporate purposes (e.g. Dividends, other capital-budgeting projects, interest payments). By contrast, other forms of inflow such as earnings with ARR are an artificial construct.
NPV uses all cash flows. Many other capital budgeting techniques incl PB ignore cash flows beyond a particular date.
NPV discounts the cash flows properly. We know the time value of money is a pervasive factor in human behavior. Other approaches incl. PB and ARR may ignore this aspect.
NPV relates projects to improvements wealth. All projects are evaluated on the basis that they increase shareholders wealth, rather than some mere ‘managerial objective’ as with PB and ARR.
NPV is better than IRR, the next-best alternative. IRR also does most of these as is closely related to NPV, but can rank inconsistently depending on the scale, timing and signs of cash flows with mutually exclusive projects. IRR also has an unrealistic reinvestment rate assumption for interim cash flows.