DQ 1(8) From textbook: \"On a purely theoretical basis, NPV is the better approa
ID: 2496586 • Letter: D
Question
DQ 1(8) From textbook: "On a purely theoretical basis, NPV is the better approach to capital budgeting as
a result of several factors. Most important, the NPV measures how much wealth a project creates (or destroys if the NPV is negative) for shareholders. Given that the financial manager’s objective is to maximize shareholder wealth, the NPV approach has the clearest link to this objective and therefore is the “gold standard” for evaluating investment opportunities."
DQ1. Which capital investment technique does the discussion in the textbook favor? Why? Do you agree with this assessment?
Explanation / Answer
The Capital Investment Technique discussed in the textbook favors is the Net Present Value (NPV) technique.
The technique of the Net Present Value (NPV) is favored in the textbook because it highlights that the NPV technique helps in the determination of the financial health i.e. wealth of a project. It provides a basis for evaluation of the projects and hence it is termed as a gold standard against which appropriate decisons can be made.
Yes, I agree with the assessment the textbook favors. This is because of the following reasons:
i. Net Present Value technique calculates the present value of the cash flows, hence it takes into consideration the time value of money and all the cash flows of the project till the project ends.
ii. As compared to techniques like Pay Back Period and Internal rate of Return, the Net Present Value technique has an upper hand in determination of the wealth that the project creates or detroys for the shareholders.
iii. Net Present Value technique can be termed as a gold standard because it is easy to calculate and understand. other techniques like the Internal rate of Return can be very complex to calculate.
iv. Net Present Value technique also acts as a benchmark because it helps to compare various investments and helps enhances proper decision making for the financial managers'.
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