Question

Making the accept or reject decision Pheasant Pharmaceuticals's decision to accept or reject project Alpha is independent of its decisions on other projects. If the firm follows the NPV method, it should project Alpha. Which of the following statements best explains what it means when a project has an NPV of $0? When a project has an NPV of $0, the project is earning a rate of 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 is positive. When a project has an NPV of $0, the project is earning a profit of $0. A firm should reject any project with an NPV of $0, because the project is not profitable. When a project has an NPV of $0, the project is earning a rate of 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 project is earning the required minimum rate of return.

Answer 1

The project's NPV is computed as shown below:

= Initial investment + Present value of future cash flows

The present value is computed as follows:

= Future value / (1 + r)ⁿ

So, the project's NPV will be as follows:

= - $ 600,000 + $ 325,000 / 1.07 + $ 500,000 / 1.07² + $ 400,000 / 1.07³ + $ 425,000 / 1.07⁴

= $ 791,207 Approximately

Since the NPV of the project is positive, hence the firm shall accept the project.

The statement that when a project has an NPV of $ 0, the project is earning a rate of 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 project is earning the required minimum rate of return best explains what it means when a project has an NPV of $ 0.

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