Discuss the pros and cons of net present value.
The basic objective of a corporation is to maximize the wealth of its stockholders. Stockholders’ wealth is measured by the value of their shares, so it can be said that the basic objective of a corporation is to maximize the value of the corporation’s stock.
In order to accomplish this basic objective, a firm’s managers must know how the actions they take will affect the value of the firm’s stock. They must know, for example, how much a plan under consideration will increase or decrease the value of the firm’s stock if the plan is put into effect.
What managers need, then, is a capital budgeting decision tool that will tell them how much a plan that is under consideration will increase or decrease the value of the firm’s stock if it is put into effect.
Academics are always telling us the Net Present Value (NPV) method of evaluating investment proposals is the best and most correct of all the methods available. Why do you think they say this? In other words, what is it about the NPV method that makes academics prefer it to all other methods?
A second issue about the NPV is if it is so great, why don’t all companies everywhere use it? For that matter, why don’t all individuals use it? In other words, what is it about the NPV method that makes people want to use, say, the IRR or payback period methods to evaluate investments instead?
