Benefits of NPV
NPV denotes Net Present Value and it is the current worth of a future investment’s net cash flow minus the first investment. If this value is positive, then the investment ought to be made unless there is a better investment option offered. The following are key advantages of using the NPV.
1. Allows for proper investment
Many companies use the net present value to make sure that they only invest in worthwhile projects. In general, if an organization is planning to undertake a new venture, whose net cash flow is going to result in an undesirable NPV, then this means that the organization would be at an advantage by investing the money in another project rather than beginning the new venture. On the other hand, if the venture has a positive NPV, then it could possibly be worth pursuing, even though there might be other projects that could be even more profitable.
2. Considers various factors
NPV allows for consideration of different things like the investment opportunity costs, interest rates as well as the cost of capital. This is very beneficial, particularly for long-term ventures. It also takes into consideration the opportunity cost, which is also known as the time worth of money. As a result, the NPV enables a company to consider the risk of prospective cash flow and tells whether the investment is going to enhance the value of the firm.
3. Provides better forecast
Another key benefit of NPV is that it also takes uncertain cash flow and inflation into account. This means that any decision that is going to be made largely depends on the available data as well as the total time of the project.
The major shortcoming of the net present value is basically the fact that it is expressed as dollars rather than as a percentage. Apart from that it also needs an estimate of the total capital to properly calculate the NPV.