What are the limitations of NPV when evaluating alternative investment proposals?

NPV is an excellent way to evalue alternative investment proposals. The problem is that in order to use NPV you must estimate the cash flows for each investment alternative. The validity of your answer will depend on the accuracy of your cash flow estimates.

Where cash flows are uncertain, you should incorporate probability theory into your NPV calculations. Discussing how to use probability theory is beyond the scope of this type of question and answer medium. However, in its simplest application , it involves weighting alternative cash flows for each investment alternative by the probability that they will occur.

The other issue with NPV is choosing an appropriate discount rate. Using different discount rates might favor one investment versus another. The best way to deal with this is try multiple discount rates within a range of possibilities to determine the sensitivity of the answer to the discount rate.

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　　Business Invest 　　Business Debt 　　Bond Investment 　　Angel Funds 　　Alternative Investment

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