The apparent advantage of Net Present Value（NPV）method is that it takes into account the time value of money, it recognizes that money received today is more valuable than the equivalent amount received in the future. Discounting each cash flow back to its present value using appropriate cost of capital, if present value of future cash flows exceeds the initial investment incurred, the difference indicates increase in shareholders’ wealth. It is an absolute figure rather than relative percentage.
Some limitations with NPV are as follows:
It assumes that the cost of capital does not change over time, in fact, it is not the case. Company are operating in dynamic environment, and facing many uncertainties, thus cost of capital must be adjusted to adapt. Another problem relating to NPV method is that it is based on some estimation, such as the cash flows which are often difficult to determine in fact.
Although NPV method has some limitations, it is still the best method to be used in investment appraisal.
In addition, modified internal rate of return (MIRR) is the rate at which the project breaks even, assuming that cash is reinvested at the firm’s current cost of capital. It is useful since it indicates the maximum cost of capital than the project could sustain before becoming financially non-viable.
