Figure 20.8 illustrates the calculation of the net present value and the investment value of the project. Do both values indicate the same investment decision
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In other words, it measures the profitability of a project by comparing the present value of expected future cash flows to the initial investment. On the other hand, the investment value of a project is the total expected return from the project. It is the sum of Show more…
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1. Net present value (NPV) Evaluating cash flows with the NPV method The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions. Consider this case: Suppose Celestial Crane Cosmetics is evaluating a proposed capital budgeting project (project Beta) that will require an initial investment of $3,225,000. The project is expected to generate the following net cash flows: Year Cash Flow Year 1 $300,000 Year 2 $450,000 Year 3 $500,000 Year 4 $500,000 Celestial Crane Cosmetics’s weighted average cost of capital is 10%, and project Beta has the same risk as the firm’s average project. Based on the cash flows, what is project Beta’s NPV? a) -$5,088,208 b) -$1,863,208 c) -$2,235,850 d) -$1,413,208 Making the accept or reject decision Celestial Crane Cosmetics’s decision to accept or reject project Beta is independent of its decisions on other projects. If the firm follows the NPV method, it should ______ project Beta. a) accept b) reject Suppose your boss has asked you to analyze two mutually exclusive projects—project A and project B. Both projects require the same investment amount, and the sum of cash inflows of Project A is larger than the sum of cash inflows of project B. A coworker told you that you don’t need to do an NPV analysis of the projects because you already know that project A will have a larger NPV than project B. Do you agree with your coworker’s statement? a) Yes, project A will always have the largest NPV, because its cash inflows are greater than project B’s cash inflows. b) No, the NPV calculation will take into account not only the projects’ cash inflows but also the timing of cash inflows and outflows. Consequently, project B could have a larger NPV than project A, even though project A has larger cash inflows. c) No, the NPV calculation is based on percentage returns, so the size of a project’s cash flows does not affect a project’s NPV.
Adi S.
1. Net present value (NPV) Evaluating cash flows with the NPV method The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions. Consider this case: Suppose Happy Dog Soap Company is evaluating a proposed capital budgeting project (project Beta) that will require an initial investment of $3,000,000. The project is expected to generate the following net cash flows: Year Cash Flow Year 1 $300,000 Year 2 $500,000 Year 3 $400,000 Year 4 $500,000 Happy Dog Soap Company’s weighted average cost of capital is 10%, and project Beta has the same risk as the firm’s average project. Based on the cash flows, what is project Beta’s NPV? -$1,672,017 -$4,672,017 $1,327,983 -$1,272,017 Making the accept or reject decision Happy Dog Soap Company’s decision to accept or reject project Beta is independent of its decisions on other projects. If the firm follows the NPV method, it should project Beta. Suppose your boss has asked you to analyze two mutually exclusive projects—project A and project B. Both projects require the same investment amount, and the sum of cash inflows of Project A is larger than the sum of cash inflows of project B. A coworker told you that you don’t need to do an NPV analysis of the projects because you already know that project A will have a larger NPV than project B. Do you agree with your coworker’s statement? A. Yes, project A will always have the largest NPV, because its cash inflows are greater than project B’s cash inflows. B. No, the NPV calculation will take into account not only the projects’ cash inflows but also the timing of cash inflows and outflows. Consequently, project B could have a larger C. NPV than project A, even though project A has larger cash inflows. C. No, the NPV calculation is based on percentage returns, so the size of a project’s cash flows does not affect a project’s NPV.
The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions. Consider this case: Suppose Lumbering Ox Truckmakers is evaluating a proposed capital budgeting project (project Beta) that will require an initial investment of $2,750,000. The project is expected to generate the following net cash flows: Year Cash Flow Year 1 $275,000 Year 2 $450,000 Year 3 $475,000 Year 4 $475,000 Lumbering Ox Truckmakers’s weighted average cost of capital is 10%, and project Beta has the same risk as the firm’s average project. Based on the cash flows, what is project Beta’s NPV? -$1,171,793 $1,303,207 -$1,446,793 -$971,793 Making the accept or reject decision Lumbering Ox Truckmakers’s decision to accept or reject project Beta is independent of its decisions on other projects. If the firm follows the NPV method, it should ______ (Accept or Reject) project Beta. Suppose your boss has asked you to analyze two mutually exclusive projects—project A and project B. Both projects require the same investment amount, and the sum of cash inflows of Project A is larger than the sum of cash inflows of project B. A coworker told you that you don’t need to do an NPV analysis of the projects because you already know that project A will have a larger NPV than project B. Do you agree with your coworker’s statement? * No, the NPV calculation will take into account not only the projects’ cash inflows but also the timing of cash inflows and outflows. Consequently, project B could have a larger NPV than project A, even though project A has larger cash inflows. * No, the NPV calculation is based on percentage returns, so the size of a project’s cash flows does not affect a project’s NPV. * Yes, project A will always have the largest NPV, because its cash inflows are greater than project B’s cash inflows.
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