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In: Finance

Suppose Blue Hamster Manufacturing Inc. is evaluating a proposed capital budgeting project (project Alpha) that will...

Suppose Blue Hamster Manufacturing Inc. is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $600,000. The project is expected to generate the following net cash flows:

Year Cash Flow
1 $275,000
2 $500,000
3 $425,000
4 $450,000

1. Blue Hamster Manufacturing Inc.’s weighted average cost of capital is 7%, 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)?

$183,958

$940,750

$901,552

$783,958

2. Blue Hamster Manufacturing Inc.’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.

Accept or Reject

3. Which of the following statements best explains what it means when a project has an NPV of $0?

A. 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.

B. 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.

C. 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.

Solutions

Expert Solution

Question Answer
                   1 $783,958
                   2 ACCEPT

Question 3: The correct choice is option "B' -  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.

Explanation:

Year Cash flow 1+r PVIF PV
               -   -       600,000           1.07      1.0000 -       600,000
                1          275,000      0.9346          257,009
                2          500,000      0.8734          436,719
                3          425,000      0.8163          346,927
                4          450,000      0.7629          343,303
NPV          783,958

The project will be accepeted as its NPV is not negtaive.

jeff jeffy answered 2 years ago
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