What is a disadvantage of NPV calculations?

What is a disadvantage of NPV calculations?

• A. Considers all cash flows
• B. Future cash flows may be uncertain
• C. Uses time value of money
• D. Simple comparison of projects

Answer: (B)

Future cash flows may be uncertain is a significant disadvantage of net present value (NPV) calculations. NPV relies on estimating future cash flows generated by a project or investment, and these estimates can be influenced by a multitude of factors such as market conditions, competitive actions, regulatory changes, and economic outlook. Given that projections are inherently probabilistic and subject to change, misestimating these cash flows can lead to incorrect conclusions regarding the viability of a project. When cash flows are uncertain, the reliability of the NPV as a decision-making tool comes into question, as it may not accurately reflect the true value of the investment. In contrast, NPV does take into account all cash flows, applies the time value of money, and provides a straightforward method for comparing projects, which are considered strengths rather than disadvantages. These aspects make NPV a comprehensive tool for evaluating investments, but the uncertainty associated with future cash flows is a critical limitation that practitioners must carefully manage.

Future cash flows may be uncertain is a significant disadvantage of net present value (NPV) calculations. NPV relies on estimating future cash flows generated by a project or investment, and these estimates can be influenced by a multitude of factors such as market conditions, competitive actions, regulatory changes, and economic outlook. Given that projections are inherently probabilistic and subject to change, misestimating these cash flows can lead to incorrect conclusions regarding the viability of a project. When cash flows are uncertain, the reliability of the NPV as a decision-making tool comes into question, as it may not accurately reflect the true value of the investment.

In contrast, NPV does take into account all cash flows, applies the time value of money, and provides a straightforward method for comparing projects, which are considered strengths rather than disadvantages. These aspects make NPV a comprehensive tool for evaluating investments, but the uncertainty associated with future cash flows is a critical limitation that practitioners must carefully manage.