Question

The decision on capital budgeting using the NPV method may be at risk of being a...

The decision on capital budgeting using the NPV method may be at risk of being a wrong decision if it is based on inaccurate estimates for

Select one:

a. the cost of capital and underestimating management’s desire for the return of their money.

b. the cost of capital and the future projections of cash flows.

c. future projections of cash flows and having unconventional cash flows resulting from this.

d. the internal rate of return being different from the cost of capital.

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Homework Answers

Answer #1

Correct Answer is (b) : the cost of capital and the future projection of cash flows.

Under the NPV method, the cost of capital and future projections of cash flows are the most important components of a capital budgeting decision and inaccurate estimates of these may lead to risk of taking a wrong decision.

To calculate NPV, future projections of cash flows are to be discounted @ cost of capital. Hence, both of these components play a vital role in calculating NPV and capital budgeting decision under NPV method is based on taking their correct estimates.

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