Suppose Cute Camel Woodcraft Company is evaluating a proposed capital budgeting

Question

Suppose Cute Camel Woodcraft Company is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $400,000. The project is expected to generate the following net cash flows: Cute Camel Woodcraft Company's weighted average cost of capital is 8%, 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)? $1, 313, 447 $1, 186, 136 $1, 463, 447 $988, 447 Making the accept or reject decision Cute Camel Woodcraft Company'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 following statements best explains what it means when a project has an NPV of $0? When a project has an NPV of $0, the project is earning a rate of return less than 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.

Explanation / Answer

Year

Cash flow

PV Factor @ 8%

PV

0

                             $ (400,000)

1.0000

         $ (400,000)

1

                             $ 325,000

0.9259

             $ 300,926

2

                            $ 400,000

0.8573

           $ 342,936

3

                            $   475,000

0.7938

             $ 377,070

4

                            $ 500,000

0.7350

             $ 367,515

NPV

            $ 988,447

1)Project Alpha’s Net Present Value is $ 988,447

2)As NPV is positive , Cute Camel Woodcraft should accept project Alpha.

3) When a project has an NPV of $ 0,

Statement 3rd is best explanation.

When a project has an NPV of $ 0, 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 NPV of $ 0 , because the project is earning the minimum rate of return.

Year

Cash flow

PV Factor @ 8%

PV

0

                             $ (400,000)

1.0000

         $ (400,000)

1

                             $ 325,000

0.9259

             $ 300,926

2

                            $ 400,000

0.8573

           $ 342,936

3

                            $   475,000

0.7938

             $ 377,070

4

                            $ 500,000

0.7350

             $ 367,515

NPV

            $ 988,447

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