Question

The president of a large company was asked why the company was holding onto a large amount of cash, instead of investing the cash. The reply was, "Because we see a lack of available positive NPV projects."

For this question, prepare 3–4 paragraphs as if a new colleague you are mentoring who is not as knowledgeable as you about finance or accounting reads the above statement. Consider:

• Detailing for your colleague what the statement means and why it is important.
• Providing an example of at least one project that may have a negative NPV but be worth doing. For example, perhaps the company is posting monitors all over its office to provide employees weather, traffic, and news.

Answer 1

Follow the explanation,

Colleague, "This statement is something that relates with time value of money, this concept says that today dollar value will be more valuable than that after certain time. This is because of, what you might have already known about is, inflation.

So the president is saying that there are no positive NPV projects, this means that if we invest this money now it will result in loss owing to time value of money. Let us go through an example.

If I invest an amount of 100,000 in a project, whose return is 8%. Then I would get 108,000 after 1 year. But consider the rate of interest prevailing in the market which is 10% which would yield 110,000. Therefore there is a negative 2,000 as a result of such investment.

Hope this would do good my friend, you will gain experience on this over time".