Subject : Corporate Finance Theory
Please provide me answers with details that is based on the corporate finance theories
Q.
The NPV rule suggests that a firm must invest in all positive NPV projects regardless of the cash amount that the firm has. In practice, however, the firm’s investment amount relies heavily on its financing capacity (e.g., cash holdings or availability of new debt issuance).
Discuss why the firm’s investment decisions do not follow the NPV rule and are rather influenced by its financing capacity?
Investment decisions donot follow NPV rule because of following
reasons
1. NPV fails to accept projects when they have limited capital.
Since NPV chooses projects which has higher increase in value, but
companies may not have the requisite capital for investment.
2. In case of limitation of financing capacity Profitability index
method is better than NPV method.Profitability Index is the ratio
of PV of Cash flows to initial Investment. It can also be
calculated by following formula.PI =1+NPV/Investment. PI index
should be greater than 1 for a project to be accepted. In case of
mutually exclusive projects higher PI index project should be
accepted.
Get Answers For Free
Most questions answered within 1 hours.