The Basics of Capital Budgeting: NPV NPV The net present value (NPV) method esti
ID: 2796898 • Letter: T
Question
The Basics of Capital Budgeting: NPV NPV The net present value (NPV) method estimates how much a potential project will contribute to shereholders' wealth, and it is the best selection criterion. The larerthe NPV, the mone value the project adds; and added value means a higher stock price. In equation form, the NPV is defined as CF CF2 CFw y = (1 + r)' 1+r CFt is the expected cash flow at Time t, r is the project's risk-adjusted cost of capital, and N is its life, and cash outflows are treated as negative cash flows. The NPV calculation assumes that cash inflows can be reinvested at the project's risk-adjusted WACCWhen the firm is considering independent projects, if the project's NPV exceeds zero the firm should accept the project. When the firm is considering mutually exclusive projects, the firm should accept the project with the highest positiveNPV. Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 796. Project A 1,170 Project B1,170 670 270 320 255 220 370 270 720 What is Project A's NPV? Round your answer to the nearest cent. Do not round your intermediate calculations. What is Project B's NPV? Round your answer to the nearest cent. Do not round your intermediate calculations. If the projects were independent, which project(s) would be accepted? Soloct- If the projects were mutually exclusive, which project(s) would be accepted?Explanation / Answer
NPV is calculated by discounting the cashflows
PV = C/(1+r)^n
C - Cashflow
r - Discount rate
n - years to the cashflow
Project A:
NPV A = $121.24
Project B:
NPV B = $156.38
- If the projects were independent, choose both projects as NPV for both are positive.
- If the projects were mutually exclusive, choose project B, as NPV is higher than project A.
Rate 7.00% Year Cashflow (A) Discount rate = 1/(1+r)^(n) Present value of cashflow = A*discount rate 0 -1170.00 1.00 -1170.00 1 670.00 0.93 626.17 2 320.00 0.87 279.50 3 220.00 0.82 179.59 4 270.00 0.76 205.98 NPV 121.24Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.