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Net present value $($NPV$)$

Evaluating cash flows with the NPV method

The net present vaiue $($NFV$)$ ruie is considered one of the most common and preferred criteria that generally lesd to good inwestment decisions.

Consider this case:

Suppose Cute Camel Woodcraft Company is evaluating a proposed capital budgeting project $($project Beta$)$ that will require an initial

investment of $$2,500,000.$ The project is expected to generate the following net cash flows:

Year $3$$$450,000$

Year $4$$$425,000$

Cute Camel Woodcraft Company's weighted average cost of capital is $10\%,$ and project Beta has the same risk as the firm's awerage project. Based on

the cash flows, what is project Beta's NPV$?$

$-$$$710,884$

$-$$$10,884$

$-$$$1,393,061$

$-$$$1,160,884$

Making the accept or reject decision

Cute Camel Woodcraft Company's decision to accept or reject project Beta is independent of its decisions on other projects. If the firm follows the NPV

method, it should

$,$ project Beta.

Suppose your boss has asked you to analyze two mutually exclusive projects$-$project A and project B$.$ Both projects require the same investment

amount, and the sum of cash infiows of Project A is larger than the sum of cash infiows of project B$.$ A coworker told you that you don't need to do an

NPV analysis of the projects because you already know that project A will have a larger NPV than project B$.$ Do you agree with your coworker's

statement?

No$,$ the NPV calculation will take into account not only the projects' cash inflows but also the timing of cash inflows and outflows.

Consequently, project $B$ could have a larger NPV than project A$,$ even though project A has larger cash inflows.

No$,$ the NPV calculation is based on percentage returns, so the size of a project's cash flows does not affect a project's NPV$.$

Yes, project A will always have the largest NPN$,$ because its cash inflows are greater than projoct B$\text{'}$s cash infiows.

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