In which of the following appraisal criteria of capital budgeting, the use of varying opportunity cost…
Only the Net Present Value (NPV) criterion (a) allows the use of a time-varying opportunity cost of capital (discounting year 1 cash flow at k1, year 2 at k1 and k2, and so…
Choose your answer
In which of the following appraisal criteria of capital budgeting, the use of varying opportunity cost of capital as a discount factor is possible ?
(a) NPV
(b) IRR
(c) Pay-back Period
(d) ARR
Answer and explanation
Correct answer A
Only the Net Present Value (NPV) criterion (a) allows the use of a time-varying opportunity cost of capital (discounting year 1 cash flow at k1, year 2 at k1 and k2, and so forth). The Internal Rate of Return (IRR) yields a single constant rate and cannot be compared against multiple changing hurdle rates, while Payback Period and ARR do not discount cash flows at all.
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UGC NET Management