Which of the following statements about net present worth (NPW) as an investment analysis method is correct?

Which of the following statements about net present worth (NPW) as an investment analysis method is correct?

• A. NPW includes the time value of money as well as all cash flows
• B. NPW ignores timing of cash flows
• C. NPW is always higher than ROI
• D. NPW does not consider risk

Answer: (A)

Net present worth uses the time value of money by discounting every cash flow back to its present value, then summing those present values and subtracting the initial investment. Each cash flow—positive or negative—is considered at the time it occurs, not just the total amount over the project life. The discount rate used reflects the cost of capital and the project’s risk, so risk is implicitly incorporated through that rate. Because of this, NPW can be positive or negative depending on how the cash flows and timing line up, and it is not simply compared to ROI, which ignores the timing of money. That’s why the statement that NPW includes the time value of money as well as all cash flows is the best description.

Net present worth uses the time value of money by discounting every cash flow back to its present value, then summing those present values and subtracting the initial investment. Each cash flow—positive or negative—is considered at the time it occurs, not just the total amount over the project life. The discount rate used reflects the cost of capital and the project’s risk, so risk is implicitly incorporated through that rate. Because of this, NPW can be positive or negative depending on how the cash flows and timing line up, and it is not simply compared to ROI, which ignores the timing of money. That’s why the statement that NPW includes the time value of money as well as all cash flows is the best description.