Question

A capital budgeting project has inflows of 300 for 5 years, and an initial investment of 1,200. However, management recently decided to reduce the size of the capital budgeting project. The initial investment will decrease by 180 to 1,020 and the cash inflows will decrease by 40 to 260. As a result, in comparison to the original NPV profile, the horizontal intercept of the NPV profile for this reduced capital budgeting project shifts:

Multiple Choice

• right and the vertical intercept shifts down.

• right and the vertical intercept shifts up.

• left and the vertical intercept shifts up.

Answer 1

NPV profile’s horizontal intercept is determined by IRR. Higher IRR will shift horizontal intercept to the right.

Vertical intercept refers to NPV calculated with zero discount rate.

Original plan :

Initial investment = 1,200

Total Inflows = 300 for 5 years = 300 x 5 = 1,500

NPV = Total Inflows - Initial investment = 1,500 - 1,200 = 300

IRR using financial calculator = 7.93%

Revised plan :

Initial investment = 1,020

Total Inflows = 260 for 5 years = 260 x 5 = 1,300

NPV = Total Inflows - Initial investment = 1,300 - 1,020 = 280

IRR using financial calculator = 8.67%

Hence, based on above, horizontal intercept of the NPV profile for reduced capital budgeting project shifts right because IRR increased from 7.93% to 8 because of revised plan.

And vertical intercept shifts down because NPV reduced from 300 to 280 because of revision.

Hence, the answer is : horizontal intercept - shifts right and vertical intercept - shifts down