Which statement is a drawback of NPV?

• A. Cashflow at EOY is inaccurate
• B. NPV ignores the time value of money
• C. It does not rely on estimates
• D. It always overstates wealth

Answer: (A)

The key idea here is how NPV handles when cash flows happen. NPV discounts each cash flow to its present value, and in many calculations we model those flows as occurring at the end of each period. That end-of-period assumption is a simplification. In reality, cash flows can occur at different times within the period, and if they occur earlier or later than the end of the year, their true present value will differ from what the end-of-period timing implies. Because of this, using end-of-year cash flows can misstate the actual value of the project, making it a drawback of the method.

The other statements aren’t drawbacks in the same sense: NPV does reflect the time value of money, it does rely on estimates of future cash flows and discount rates, and, like any method, it can overstate or understate wealth depending on the assumptions.