The ________ model is usually considered the best of the capital budgeting decision-making models.
A) Internal Rate of Return (IRR)
B) Discounted Payback Period
C) Profitability Index (PI)
D) Net Present Value (NPV)
Is the correct answer D. (NPV)
Yes, the correct answer is D) Net Present Value (NPV).
The NPV model is typically considered the best of the capital budgeting decision-making models. NPV is a method used to evaluate the profitability of an investment by discounting all expected future cash flows back to their present value. The main concept behind NPV is that money received in the future is worth less than the same amount received today due to the time value of money.
To calculate NPV, you need to know the initial investment cost and the expected cash flows over the investment's life. The cash flows are then discounted using a predetermined rate of return or cost of capital. If the NPV is positive, it indicates that the investment is expected to generate more value than its initial cost and is considered financially viable.
To determine the NPV, you can use the following formula:
NPV = (Cash Flow Year 1 / (1 + r)^1) + (Cash Flow Year 2 / (1 + r)^2) + ... + (Cash Flow Year n / (1 + r)^n) - Initial Investment
Where:
- Cash Flow Year 1, Year 2, ..., Year n represents the expected future cash flows for each year of the investment's life.
- r is the discount rate or the cost of capital.
- Initial Investment is the initial cost of the investment.
By comparing the NPV of different investment options, decision-makers can identify which one is the most financially attractive and suitable for their organization.