What measure is crucial for estimating the profitability of an investment?

What measure is crucial for estimating the profitability of an investment?

• A. Internal rate of return (IRR)
• B. Net present value (NPV)
• C. Return on equity (ROE)
• D. Cap rate

Answer: (B)

Net present value (NPV) is a fundamental measure for estimating the profitability of an investment. It calculates the difference between the present value of cash inflows generated by an investment and the present value of cash outflows over a specific period. By discounting future cash flows to their present value, NPV provides a clear picture of an investment's ability to generate wealth. A positive NPV indicates that the projected earnings (in present dollars) exceed the anticipated costs, which signifies that the investment is expected to be profitable. While internal rate of return (IRR), return on equity (ROE), and capitalization rate (cap rate) are also important financial metrics, they serve different purposes in evaluating investments. For instance, IRR is used to assess the efficiency of an investment but does not take into account the actual dollar amounts of cash flow like NPV. ROE measures the profitability concerning shareholder equity, shining a light on the company's overall performance. Cap rate is primarily used in real estate to indicate the expected rate of return based on income generated from the property rather than providing a comprehensive view of net profitability over time. In summary, NPV is a key measure for assessing investment profitability because it directly reflects the value created by the investment in monetary terms

Net present value (NPV) is a fundamental measure for estimating the profitability of an investment. It calculates the difference between the present value of cash inflows generated by an investment and the present value of cash outflows over a specific period. By discounting future cash flows to their present value, NPV provides a clear picture of an investment's ability to generate wealth. A positive NPV indicates that the projected earnings (in present dollars) exceed the anticipated costs, which signifies that the investment is expected to be profitable.

While internal rate of return (IRR), return on equity (ROE), and capitalization rate (cap rate) are also important financial metrics, they serve different purposes in evaluating investments. For instance, IRR is used to assess the efficiency of an investment but does not take into account the actual dollar amounts of cash flow like NPV. ROE measures the profitability concerning shareholder equity, shining a light on the company's overall performance. Cap rate is primarily used in real estate to indicate the expected rate of return based on income generated from the property rather than providing a comprehensive view of net profitability over time.

In summary, NPV is a key measure for assessing investment profitability because it directly reflects the value created by the investment in monetary terms