2. Net present value (NPV) The capital budgeting process is comprehensive and is based on certain assumptions,...

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2. Net present value (NPV)
The capital budgeting process is comprehensive and is based oncertain assumptions, models, and benchmarks. This process oftenbegins with a project analysis. Generally, the first step in acapital budgeting project analysis—which occurs before anyevaluation method is applied—involves estimating the project’sexpected cash flows .
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 Lumbering Ox Truckmakers is evaluating a proposedcapital budgeting project (project Alpha) that will require aninitial investment of $600,000. The project is expected to generatethe following net cash flows:
Year
Cash Flow
Year 1 $300,000
Year 2 $475,000
Year 3 $500,000
Year 4 $450,000
Lumbering Ox Truckmakers’s weighted average cost of capital is9%, 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)? (Note: Do not round your intermediatecalculations.)
$1,229,910
$1,279,910
$779,910
$1,379,910
Making the accept or reject decision
Lumbering Ox Truckmakers’s decision to accept or reject projectAlpha is independent of its decisions on other projects. If thefirm follows the NPV method, it should projectAlpha.
Suppose your boss has asked you to analyze two mutuallyexclusive projects—project A and project B. Both projects requirethe same investment amount, and the sum of cash inflows of ProjectA is larger than the sum of cash inflows of project B. A coworkertold you that you don’t need to do an NPV analysis of the projectsbecause you already know that project A will have a larger NPV thanproject B. Do you agree with your coworker’s statement?
Yes, project A will always have the largest NPV, because itscash inflows are greater than project B’s cash inflows.
No, the NPV calculation will take into account not only theprojects’ cash inflows but also the timing of cash inflows andoutflows. Consequently, project B could have a larger NPV thanproject A, even though project A has larger cash inflows.
No, the NPV calculation is based on percentage returns, so thesize of a project’s cash flows does not affect a project’s NPV.

Year	Cash Flow
Year 1	$300,000
Year 2	$475,000
Year 3	$500,000
Year 4	$450,000

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Answer 1Correct answer is779910ExplanationNPV is calculated as belowAs such option C is correct and other options A B and D areincorrectAnswer 2Correct answer isNo the NPV calculation will take See Answer

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2. Net present value (NPV)The capital budgeting process is comprehensive and is based oncertain assumptions, models, and benchmarks. This process oftenbegins with a project analysis. Generally, the first step in acapital budgeting project analysis—which occurs before anyevaluation method is applied—involves estimating the project’sexpected cash flows .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 Lumbering Ox Truckmakers is evaluating a proposedcapital budgeting project (project Alpha) that will require aninitial investment of $600,000. The project is expected to generatethe following net cash flows:YearCash FlowYear 1$300,000Year 2$475,000Year 3$500,000Year 4$450,000Lumbering Ox Truckmakers’s weighted average cost of capital is9%, 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)? (Note: Do not round your intermediatecalculations.)$1,229,910$1,279,910$779,910$1,379,910Making the accept or reject decisionLumbering Ox Truckmakers’s decision to accept or reject projectAlpha is independent of its decisions on other projects. If thefirm follows the NPV method, it should projectAlpha.Suppose your boss has asked you to analyze two mutuallyexclusive projects—project A and project B. Both projects requirethe same investment amount, and the sum of cash inflows of ProjectA is larger than the sum of cash inflows of project B. A coworkertold you that you don’t need to do an NPV analysis of the projectsbecause you already know that project A will have a larger NPV thanproject B. Do you agree with your coworker’s statement?Yes, project A will always have the largest NPV, because itscash inflows are greater than project B’s cash inflows.No, the NPV calculation will take into account not only theprojects’ cash inflows but also the timing of cash inflows andoutflows. Consequently, project B could have a larger NPV thanproject A, even though project A has larger cash inflows.No, the NPV calculation is based on percentage returns, so thesize of a project’s cash flows does not affect a project’s NPV.