Which of the following is a simplifying assumption commonly made in net present value (NPV) analysis?

• A. Depreciation is ignored in all calculations.
• B. Net sales are always equal to gross sales.
• C. All cash flows occur at the end of each period.
• D. The discount rate changes every year.

Answer: (C)

Verified step by step guidance

1. Understand the concept of Net Present Value (NPV): NPV is a method used in capital budgeting to evaluate the profitability of an investment or project by calculating the present value of expected future cash flows, discounted at a specific rate.
2. Identify simplifying assumptions in NPV analysis: Simplifying assumptions are used to make calculations more manageable and consistent. These assumptions may not perfectly reflect real-world scenarios but are commonly accepted for analysis purposes.
3. Review the options provided: Analyze each option to determine whether it is a commonly made simplifying assumption in NPV analysis. For example, depreciation is not ignored in all calculations, and net sales are not always equal to gross sales.
4. Focus on the assumption that 'All cash flows occur at the end of each period': This is a widely accepted simplifying assumption in NPV analysis. It assumes that cash flows are lumped together and occur at the end of each period, making it easier to calculate their present value.
5. Understand why the discount rate does not change every year: In NPV analysis, the discount rate is typically assumed to remain constant throughout the analysis period to simplify calculations and ensure consistency.