Question

Everest plc is considering investing in a number of new investment projects

– A, B, and C. The expected pattern of net cash flows for each project are:

	A	B	C
	000
0	(370)	(800)	(950)
1	115	200	250
2	115	200	250
3	200	200	290
4	300	350	290
5	350	350	400

The company’s cost of capital is 8%. Everest plc wishes to use net present value (NPV) to assess the three projects. (i) Outline the Net Present Value (NPV) rule for the following investment scenarios: (a) to decide whether a specific project is worthwhile (b) to decide between two mutually exclusive projects (ii) Critically discuss why the net present value (NPV) method is considered to be theoretically superior to other appraisal methods. (iii) Calculate each project’s net present value. Explain whether you would recommend to Everest plc to proceed with each project based on NPV assuming they have no constraints on how many projects to adopt. (iv) Explain briefly how the above calculations would change if Everest plc had a maximum capital investment budget of €1,000,000.

Answer 1

(i) NPV Rule : The net present value rule is the idea that company managers and investors should only invest in projects, or engage in transactions that have a positive net present value (NPV). They should avoid investing in projects that have a negative net present value.

(a) A specific project is worthwhile if that project's NPV is positive.

(b) Between two mutually exclusive projects that project is decided whose NPV is more than the other and also greater than zero.

(ii)  the net present value (NPV) method is considered to be theoretically superior to other appraisal methods