Question

true or false

1.For a normal, or conventional, project, the net present value of a project is positive when the required rate of the project is higher than the internal rate of return of the project.

2.Despite the easiness of calculating, payback period is not commonly used in small businesses.

3.The cash flow from old equipment that is replaced by new equipment is included in the capital budgeting calculation of cash flows from the new equipment project.

Answer 1

(1) False,

The IRR is the Rate of Return generated by the project. NPV is the Amount generated in excess of required rate of return.

NPV = PV of Cash Inflows - PV of Cash Outflows

Cash inflows while computing NPV will be discounted at Required rate of return. If the Required rate is higher than IRR, then obviously PV of Cash Inflows eill be lessthan PV of CAsh Out flows, resulting in Negative NPV.

So, The net present value of a project will be nagative if the required rate of the project is higher than the internal rate of return of the project.

(2) False

Payback period method is suitable for projects of small investments. It not worth spending much time and effort in sophisticated economic analysis in such projects.

(3) True

As the Initial Cash Outflow due to purchase of new equipment should be net of Cash inflows from disposal of old equipment.

The Cash Flow from Old Equipment that is replaced by new equipment is included in the capital budgeting calculation of cash flows from the new equipment project.