Question

1. Net present value (NPV) Evaluating cash flows with the NPV method The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions. Consider this case: Suppose Fuzzy Button Clothing Company is evaluating a proposed capital budgeting project (project Beta) that will require an initial investment of $3,000,000. The project is expected to generate the following net cash flows: Year Year 1 Year 2 Year 3 Year 4 Cash Flow $300,000 $450,000 $475,000 $500,000 Fuzzy Button Clothing Company's weighted average cost of capital is 9%, and project Beta has the same risk as the firm's average project. Based on the cash flows, what is project Beta's NPV? -$4,625,015 0-$1,625,015 O-$1,150,015 O-$1,125,015

Answer 1

1)

NPV = Present value of cash inflows - present value of cash outflows

NPV = -3,000,000 + 300,000 / (1 + 0.09)¹ + 450,000 / (1 + 0.09)² + 475,000 / (1 + 0.09)³ + 500,000 / (1 + 0.09)⁴

NPV = -$1,625,015

2)

Reject

A project having negative NPV should always be rejected

3)

Yes, project A will have the largest NPV, because its cash inflows are greater than project B's cash inflows.