Describe the net present social value model for making capital budgeting decisions. Giving at least one specific example, explain how social value might be measured. What role does the NPV model play in not-for-profit management? Explain your reasoning, giving examples as necessary.
Describe the net present social value model for making capital budgeting decisions. Giving at least one specific example, explain how social value might be measured. What role does the NPV model play in not-for-profit management? Explain your reasoning, giving examples as necessary.
Related questions
Capital budgeting involves choosing projects that add value to the firm. The net present value (NPV), internal rate of return (IRR) and payback period methods are the most common approaches to project selection. At its core, capital budgeting is measuring an accounting of costs versus benefits. In a way, all business decisions are a series of capital budgeting decisions. Get it wrong, and you can destroy a company.
The capital budgeting tools help financial managers decide on the desirability of the projects. In the real world, however, managers sometimes will make decisions that don't necessarily agree with the decision rules of the payback period, NPV or IRR methods.
For example, consider the two mutually exclusive projects below.
| Investments | Cost | Cash Flow 1 | Cash Flow 2 |
| Project A | $ 50 | $ - | $ 100 |
| Project B | $ 50 | $ 50 | $ 25 |
According to the payback period, project B should be selected. Although both projects cost the same, project B has a payback period of one period, while project A will payback in roughly 1.5 periods.
Assuming the discount rate of 5%, NPV(A) = $41 and NPV(B) = $20.
This example illustrates the limitations of the payback period method. Even though the payback period method points to project B, the NPV method points to project A since it has more than twice the NPV value to that of project B. Yet the manager may choose project A. Why?
It may be that the project stakeholder is requesting a quicker return in cash.
For this discussion, create an example problem where two (or more) methods contradict each other. What would be the "appropriate" choice (which project would you choose)? In what cases would you not choose the "best" choice?
