1. Net present value (NPV) Evaluating cash flows with the NPV method The net present value (NPV)...

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Finance

1. Net present value (NPV)
Evaluating cash flows with the NPV method
The net present value (NPV) rule is considered one of the mostcommon and preferred criteria that generally lead to goodinvestment decisions.
Consider this case:
Suppose Cold Goose Metal Works Inc. is evaluating a proposedcapital budgeting project (project Alpha) that will require aninitial investment of $450,000. The project is expected to generatethe following net cash flows:
Year
Cash Flow
Year 1 $325,000
Year 2 $425,000
Year 3 $450,000
Year 4 $500,000
Cold Goose Metal Works Inc.’s weighted average cost of capitalis 10%, and project Alpha has the same risk as the firm’s averageproject. Based on the cash flows, what is project Alpha’s netpresent value (NPV)?
$426,293
$876,293
$1,326,293
$1,201,293
Making the accept or reject decision
Cold Goose Metal Works Inc.’s decision to accept or rejectproject Alpha is independent of its decisions on other projects. Ifthe firm follows the NPV method, it should projectAlpha.
Which of the following statements best explains what it meanswhen a project has an NPV of $0?
When a project has an NPV of $0, the project is earning a rateof 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 projectis earning the required minimum rate of return.
When a project has an NPV of $0, the project is earning a profitof $0. A firm should reject any project with an NPV of $0, becausethe project is not profitable.
When a project has an NPV of $0, the project is earning a rateof 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 ispositive.

Year	Cash Flow
Year 1	$325,000
Year 2	$425,000
Year 3	$450,000
Year 4	$500,000

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1. Net present value (NPV)Evaluating cash flows with the NPV methodThe net present value (NPV) rule is considered one of the mostcommon and preferred criteria that generally lead to goodinvestment decisions.Consider this case:Suppose Cold Goose Metal Works Inc. is evaluating a proposedcapital budgeting project (project Alpha) that will require aninitial investment of $450,000. The project is expected to generatethe following net cash flows:YearCash FlowYear 1$325,000Year 2$425,000Year 3$450,000Year 4$500,000Cold Goose Metal Works Inc.’s weighted average cost of capitalis 10%, and project Alpha has the same risk as the firm’s averageproject. Based on the cash flows, what is project Alpha’s netpresent value (NPV)?$426,293$876,293$1,326,293$1,201,293Making the accept or reject decisionCold Goose Metal Works Inc.’s decision to accept or rejectproject Alpha is independent of its decisions on other projects. Ifthe firm follows the NPV method, it should projectAlpha.Which of the following statements best explains what it meanswhen a project has an NPV of $0?When a project has an NPV of $0, the project is earning a rateof 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 projectis earning the required minimum rate of return.When a project has an NPV of $0, the project is earning a profitof $0. A firm should reject any project with an NPV of $0, becausethe project is not profitable.When a project has an NPV of $0, the project is earning a rateof 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 ispositive.