Question

Evaluating cash flows with the NPV method

The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions.

Consider this case:

Suppose Fuzzy Button Clothing Company is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $450,000. The project is expected to generate the following net cash flows:

Year	Cash Flow
Year 1	$325,000
Year 2	$475,000
Year 3	$450,000
Year 4	$425,000

Fuzzy Button Clothing Company’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)?

A) $1,385,186

B) $1,285,186

C) $960,186

D) $1,152,223

Making the accept or reject decision

Fuzzy Button Clothing Company’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 (reject/accept) project Alpha.

Answer 1

Net present value is the difference between present value of Cash inflow and present value of cash outflow.

Based on the cashflows ,alpha Net Present value of project alpha is $ 960186.

Therefore option (C) $960186. IS CORRECT.

Project should be accepted when NPV is positive.Therefore as NPV of Project alpha is positive project should be accepted.

For detailed calculation of NPV refer the sheet attached below:-->