Question

Suppose Lumbering Ox Truckmakers is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $450,000. The project is expected to generate the following net cash flows:

Year	Cash Flow
Year 1	$375,000
Year 2	$425,000
Year 3	$500,000
Year 4	$450,000

Lumbering Ox Truckmakers’s weighted average cost of capital is 10%, and project Alpha has the same risk as the firm’s average project. Based on the cash flows, what is project Alpha’s net present value (NPV)?

$925,162

$475,162

$1,300,162

$1,425,162

Making the accept or reject decision

Lumbering Ox Truckmakers’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

Year Cash flow 0 $ (450,000) 1 $ 375,000 2 $ 425,000 3 $ 500,000 41 $ 450,000 PVIF@10% 1.000 $ 0.909 $ 0.826 $ 0.751 $ 0.683 $ Present value (450,000) 340,909 351,240 375,657 307,356 Net present value 925,162 It should accept project Alpha. Select "It's OK to accept a project with an NPV of $0, because the project is earning the required minimum rate of return."

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