Which method evaluates capital budgeting projects by calculating the difference between cash inflows and cash outflows?

The method that evaluates capital budgeting projects by calculating the difference between cash inflows and cash outflows is the net present value (NPV). NPV measures the profitability of an investment by assessing the total expected cash inflows generated by a project, discounted back to their present value, and subtracting the initial investment (which is represented as cash outflows). A positive NPV indicates that the project's inflows exceed the outflows, suggesting that it is likely to be a worthwhile investment.

This approach incorporates the time value of money, recognizing that a dollar today is worth more than a dollar in the future, which is crucial for making informed financial decisions. Thus, the project's feasibility and attractiveness are assessed based on its potential to generate value over time, leading to strategic investment decisions in capital budgeting.

In contrast, methods like the payback period focus solely on the time required to recover the initial investment without accounting for the time value of money. The internal rate of return is another metric that represents the discount rate at which the NPV equals zero but does not explicitly provide the difference between cash inflows and outflows. Return on investment expresses the efficiency of an investment but lacks depth in assessing the timing and scale of cash flows. All these differences underscore why