A- Explain fully the concept of net present value. Why must firms use net
present value to determine if an investment is profitable?
B- Assume that managers take two years off without pay to complete an MBA.
Use the concepts of opportunity cost and net present value to explain how
you would measure if an MBA is profitable?
A - Net present value (NPV) is determined by calculating the costs (negative cash flows) and benefits (positive cash flows) for each period of an investment. Because of its simplicity, NPV is a useful tool to determine whether a project or investment will result in a net profit or a loss. A positive NPV results in profit, while a negative NPV results in a loss. The NPV measures the excess or shortfall of cash flows, in present value terms, above the cost of funds.
B - If managers take two years off without pay to complete an MBA, then an MBA will be profitable, if the opportunity costs will be comparatively low and net present value of such kind of investment will be positive.