2: The Basics of Capital Budgeting: NPV

The Basics of Capital Budgeting: 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:

CF_t is the expected cash flow at Time t, r is the project's risk-adjusted cost of capital, and N is its life, 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-rdrsWACCCorrect 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 10%.

	0		1		2		3		4
Project A	-1,160		610		370		190		240
Project B	-1,160		210		305		340		690

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. $ _____

Solution

If the projects were independent, which project(s) would be accepted? -Select-(Neither, Project A, Project B, Both projects A and B) If the projects were mutually exclusive, which project(s) would be accepted? -Select-(Neither, Project A, Project B, Both projects A and B)