These techniques can be used to assess and compare different investment possibilities. The following are important capital budgeting methods:
- Net Present Value (NPV: This method calculates the future value of cash flows that are associated with an investment. It takes into consideration the time value money as well as the rate of return. The NPV refers to the difference between cash inflows (present value) and cash outflows (present value). Positive NPV means that an investment will generate more cash than it cost, which makes it a great investment opportunity.
- The Internal Rate of Return is a technique that calculates the percentage at which the investment’s net present value equals zero. It is used to evaluate the profitability of various investment options. Higher IRRs indicate a more profitable investment.