Why is net present value (NPV) used in prospect budgeting, and what is a key assumption?

• A. Discount rate used for future cash flows
• B. Historical sales trend
• C. Payback period only
• D. Cost of capital equals zero

Answer: (C)

Net present value weighs money received in the future by how much it’s worth today, so in prospect budgeting it’s used to judge whether a project adds value after accounting for the time value of money. By discounting all expected cash inflows and outflows to present value and subtracting the initial outlay, NPV provides a single number you can use to compare different options with different timing.

A key assumption is the discount rate used to discount those future cash flows. This rate represents the opportunity cost of capital and the risk of the cash flows, and the whole NPV result depends on choosing a reasonable, consistent rate for all periods. The other ideas don’t fit: historical sales trends aren’t what NPV relies on; payback period is a different metric that doesn’t factor in the time value of money; and assuming the cost of capital is zero would ignore the fundamental time-value consideration NPV is built on.