Ch 11- Assignment - The Basics of Capital Budgeting

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 Hungry Whale Electronics is evaluating a proposed capital budgeting project (project Alpha) that will require al

investment of $500,000. The project is expected to generate the following net cash flow

Year

Year 1

Year 2

Year 3

Year 4

Cash Flow

$300,000

$475,000

$500,000

$400,000

Ch 11- Assignment - The Basics of Capital Budgeting

Hungry Whale Electronics's weighted average cost of capital is 9%, and project Alpha has the same risk as the firm's average project. Based on the

cash flows, what is project Alpha's net present value (NPV)?

Ⓒ$344,489

Ⓒ$844,489

Ⓒ$1,319,409

Ⓒ$971,162

Making the accept or reject decision

Hungry Whale Electronics's decision to accept or reject project Alpha is independent of its decisions on other projects. If the firm follows the NPV

method, it should

project Alpha

Which of the folloreements best explains what it means when a project has an NPV of $07

accept

O when al

an NPV of 50, the project is earning a rate of return less than the project's weighted average cost of capital. It's OK to

accept the project, as long as the project's profit is positive.

When a project has an NPV of $0, the project is earning a profit of $0. A firm should reject any project with an NPV of 50, because the

When a project has an NPV of 50, the project is earning a rate of return equal to the project's weighted average cost of capital. It's OK to

accept a project with an NPV of $0, because the project is earning the required minimum rate of return.

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