Question

1)Under the net-present-value method, if the cost of the asset is less than the present value of the future cash flows, the:

investment's expected return is greater than the firm's cost of capital

firm's cost of capital is greater than the rate of return on assets

net-present-value is negative

investment should not be made

2) A capital investment generates a satisfactory rate of return when its return is:

Greater than the internal rate of return

Less than the cost of capital

Greater than or equal to the cost of capital

Equal to or less than the cost of capital

Answer 1

1. Under the net-present-value method, the present value of the future cash flows is determined by deducting the costs of the asset (negative cash flows) from the benefits received from it, i.e. sale receipt of asset, profit generated from it, etc (positive cash flows). Since the the present value of the future cash flows (which is the net value after deducting the cost of the asset) is greater than the cost of the asset, it means that the return from this asset is grater then its cost.

Answer: Investment's expected return is greater than the firm's cost of capital

2. Cost of capital refers to the expense incurred for borrowing the capital. For example a sum of $20,000 is borrowed at 10% interest annually. Then is simple language, the cost of capital will be the interest expense to be incurred for borrowing this money, i.e. 20,000X10% = 2,000. If this sum borrowed is utilised in the business to generate a profit of 2,000 which is equal to the interest, then there will be no loss from this investment as the expense incurred will be paid from this profit. If the profit earned is more than the interest expense then it will be a surplus. Thus generating a return equal to or greater than the cost of capital is desirable.

Answer: Greater than or equal to the cost of capital