40.In which of the following situations, the net present value may not be an app

Question

40.In which of the following situations, the net present value may not be an appropriate method be used in a capital budgeting decision?

You are examining a project, in which some of the cash flows following the initial investment are expected to be negative.

You are examining a project that is financed through multiple sources of capital.

You are examining a project that requires a relatively high cost of capital.

You are comparing mutually exclusive projects with different longevity.

You are comparing mutually exclusive projects, whose initial investment amounts significantly differ from one another.

Explanation / Answer

NPV may be a apprpriate method in all the cases given below except the projects with different longevity. The apprpriate metric to be used to analyse the projects with different periods is equated annnual benefit method/Equivalent annual costs method.
So, the answer is Option D.

NPV can be used even though initial investments are expected to be negative.
If a project has a multiple sources of capital, then weighted average cost of capital shall be used as the discount rate for discounting the cashflows
Projects with high cost of capital or different initial investments can be evaluated using NPV as the formula for NPV is
Discounted cashinflows - Cashoutflows.

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