Question

The net present value (NPV) method estimates how much a potential project will contribute to (-Select-business ethics, shareholders' wealth ,employee benefits), and it is the best selection criterion. The( -Select-smaller larger) the NPV, the more value the project adds; and added value means a (-Select-higher,lower) stock price. In equation form, the NPV is defined as:

CF_t is the expected cash flow at Time t, r is the project's risk-adjusted cost of capital, and N is its life, and cash outflows are treated as negative cash flows. The NPV calculation assumes that cash inflows can be reinvested at the project's risk-adjusted (-Select-rd, rs, WACC). When the firm is considering independent projects, if the project's NPV exceeds zero the firm should (-Select-accept, reject) the project. When the firm is considering mutually exclusive projects, the firm should accept the project with the (-Select-lowest positive, lowest negative, highest positive ,highest negative) NPV.

Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 7%.

	0		1		2		3		4
Project A	-900		650		345		290		340
Project B	-900		250		280		440		790

What is Project A's NPV? Do not round intermediate calculations. Round your answer to the nearest cent.

$  

What is Project B's NPV? Do not round intermediate calculations. Round your answer to the nearest cent.

$  

If the projects were independent, which project(s) would be accepted?

If the projects were mutually exclusive, which project(s) would be accepted?

Answer 1

The net present value (NPV) method estimates how much a potential project will contribute to shareholders' wealth, and it is the best selection criterion. The larger the NPV, the more value the project adds; and added value means a higher stock price. In equation form, the NPV is defined as:

CF_t is the expected cash flow at Time t, r is the project's risk-adjusted cost of capital, and N is its life, and cash outflows are treated as negative cash flows. The NPV calculation assumes that cash inflows can be reinvested at the project's risk-adjusted WACC. When the firm is considering independent projects, if the project's NPV exceeds zero the firm should accept the project. When the firm is considering mutually exclusive projects, the firm should accept the project with the highest positive NPV.

	Cashflows			PV of cashflowsCashflows
Year	Project A	Project B	Discounting factor @ 7%	Project A	Project B
0	-900	-900	1	-900.0	-900.0
1	650	250	0.934579439	607.5	233.6
2	345	280	0.873438728	301.3	244.6
3	290	440	0.816297877	236.7	359.2
4	340	790	0.762895212	259.4	602.7
			NPV	504.9	540.1
We know,
NPV= Present value of future cashflows from the project discounted at the required rate of return
NPV of Project A= 504.9
NPV of Project B= 540.1
If the project were independent, choose both the projects as NPV is positive in both case
If the project were mutually exclusive, choose Project B as it has higher NPV than Project A.