Benefits and drawbacks

In this lesson

1. 0:00 Benefits and drawbacks of NPV
2. 0:10 Time value of money advantage
3. 0:19 Shareholder wealth impact measurement
4. 0:33 Cash flows versus profits advantage
5. 0:43 Risk accounting and project timeline
6. 1:06 NPV drawbacks and limitations

About this lesson

The main advantages of NPV are significant. It accounts for the time value of money, directly measures impact on shareholder wealth (the primary goal of any business), uses objective cash flows rather than profit estimates, and considers the entire project timeline from start to finish. You can also build risk into the discount rate and use complementary techniques for deeper analysis. This makes NPV more comprehensive than simpler methods like payback. However, NPV has real drawbacks you need to recognise. It can be complex and difficult for non-financial managers to understand, especially when projects involve hundreds or thousands of cash flows. Calculating an accurate cost of capital is challenging because interest rates and shareholder expectations change over time. Additionally, NPV focuses heavily on long-term projects and may overlook short-term operational issues or liquidity concerns, which can be critical in practice. Mastering both the benefits and limitations prepares you to evaluate NPV critically in exams and explain when alternative or complementary techniques might be more appropriate for specific business situations.

Duration: 2m