2,3,4 2. Your software firm earns zero profits due to intense competition. You c

Question

2,3,4

2. Your software firm earns zero profits due to intense competition. You can develop a new prod uct that will earn net profits of $1 million for each of the next three years before the competition catches up. Should you develop it if the initial investment today is $2.7 million and if the annual interest rate is 10%? 3. Which of the following statements regarding the NPV rule and the rate of return rule is false? (a) Accept a project if its NPV>0 (b) Reject a project if the NPV 0 (d) Accept a project if its rate of return > opportunity cost of capital 4. Which of the following statements regarding the net present value rule and the rate of return rule is false? (a) Accept a project if NPV > cost of investment. (b) Accept a project if NPV is positive. (c) Accept a project if return on investment exceeds the rate of return on an equivalent-risk investment in the financial market. (d) Reject a project if NPV is negative.

Explanation / Answer

Ans:

2)

Decision to develop the new product should be based on net present value.

Computation of NPV

NPV = cash flow * 1/(1+r)^n

NPV = -$2.7 million * 1/(1+.10)^0 + $1 million * 1/(1+0.10)^1 + $1 million * 1/(1+0.10)^2 + $1 million * 1/(1+0.10)^3

= -$2.7 million * 1 + $1 million * 0.9091 + $1 million * 0.8264 + $1 million * 0.7513

= -$2.7 million + $0.9091 million + $0.8264 million + $0.7513 million

= -$2.7 million + $2.4868 million

= -$0.2132 million

Since the net present value is negative, new product should not be developed.

3) Option C

Accept a project if its rate of return greater than 0

The project should be accepted if the rate of return is greater than the minimum rate of return.i.e cost of capital.

4) Option A

Accept a project if NPV greater than cost of investment.

A project should be accepted if the NPV is positive and a project should be rejected if the NPV is negative.

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.