Which of the following capital budgeting techniques best captures the dollar amount of cash flows, time value of money and risk associated with cash flows? Select the most correct answer. Group of answer choices Accounting rate of return Payback period Discounted payback period Net present value Net book value
Question
Which of the following capital budgeting techniques best captures the dollar amount of cash flows, time value of money and risk associated with cash flows? Select the most correct answer.
Group of answer choices
Accounting rate of return
Payback period
Discounted payback period
Net present value
Net book value
Solution
The most correct answer is "Net present value".
Here's why:
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Dollar Amount of Cash Flows: Net Present Value (NPV) uses the projected cash inflows and outflows expected from the project. It directly considers the dollar amount of cash flows.
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Time Value of Money: NPV discounts the future cash flows back to the present value, which means it takes into account the time value of money. The time value of money is the concept that money available today is worth more than the same amount in the future due to its potential earning capacity.
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Risk Associated with Cash Flows: The discount rate used in the NPV calculation is a reflection of the risk associated with the project. A higher discount rate is used for riskier projects, which reduces the present value of the cash inflows. This means that NPV also considers the risk associated with the cash flows.
Therefore, among the given options, Net Present Value best captures the dollar amount of cash flows, time value of money, and risk associated with cash flows.
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