Question

Capital Budgeting Decision Criteria: NPV

NPV

The net present value (NPV) method estimates how much a potential project will contribute to -Select-business ethicsshareholders' wealthemployee benefitsCorrect 1 of Item 1, and it is the best selection criterion. The -Select-smallerlargerCorrect 2 of Item 1 the NPV, the more value the project adds; and added value means a -Select-higherlowerCorrect 3 of Item 1 stock price. In equation form, the NPV is defined as:

CFt is the expected cash flow in Period t, r is the project's risk-adjusted cost of capital, and cash outflows are treated as negative cash flows. The NPV calculation assumes that cash inflows can be reinvested at the project's risk-adjusted -Select-rd       rs       WACCCorrect 4 of Item 1. When the firm is considering independent projects, if the project's NPV exceeds zero the firm should -Select-acceptrejectCorrect 5 of Item 1 the project. When the firm is considering mutually exclusive projects, the firm should accept the project with the -Select-lowest positivelowest negativehighest positivehighest negativeCorrect 6 of Item 1 NPV.

Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 8%.

	0		1		2		3		4
Project A	-1,150		660		335		200		250
Project B	-1,150		260		270		350		700

What is Project A's NPV? Round your answer to the nearest cent. Do not round your intermediate calculations.

$  

What is Project B's NPV? Round your answer to the nearest cent. Do not round your intermediate calculations.

$  

If the projects were independent, which project(s) would be accepted?

-Select-NeitherProject AProject BBoth Projects A and BCorrect 1 of Item 3

If the projects were mutually exclusive, which project(s) would be accepted?

-Select-Neither       Project AProject BBoth Projects A and BCorrect 2 of Item 3

Answer 1

Solution:

PROJECT A
Year	Cash Flows	Discounted Factor @8%	Discounted Cash Flows
0	-1150	1.000	-1150
1	660	0.9259	611.094
2	335	0.8573	287.195
3	200	0.7938	158.760
4	250	0.7350	183.75
NPV			90.70

PROJECT B
Year	Cash Flows	Discounted Factor @8%	Discounted Cash Flows
0	-1150	1.000	-1150
1	260	0.9259	240.73
2	270	0.8573	231.47
3	350	0.7938	277.83
4	700	0.7350	514.50
NPV			114.53

Acceptance crirteron

Independnet Project: NPV>0 Ans: Both Projects A and B

Mutually Exclusive Project: NPV>0; And Highest Ans: Project B