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he net present value ( NPV ) method estimates how much a potential project will contribute to shareholders' wealth v v , and it is
he net present value NPV method estimates how much a potential project will contribute to shareholders' wealth and it is the best selection criterion. The larger the NPV the more value the project adds; and dded value means a higher stock price. In equation form, the NPV is defined as:
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is the expected cash flow at Time is the project's riskadjusted cost of capital, and 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 riskadjustei When the firm is considering independent projects, if the project's NPV exceeds zero the firm should the project. When the firm is considering mutually exclusive projects, the firm should accept the project with the 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' aftertax 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 year lives, and they have risk characteristics similar to the firm' average project. Bellinger's WACC is
What is Project As NPV Do not round intermediate calculations. Round your answer to the nearest cent.
$
What is Project Bs NPV Do not round intermediate calculations. Round your answer to the nearest cent.
$
If the projects were independent, which projects would be accepted?
If the projects were mutually exclusive, which projects would be accepted?
the project's riskadjusted cost of capital, then the project should be
Because of the IRR reinvestment rate assumption, when mutually exclusive projects are evaluated the IRR approach can lead to conflicting results from the NPV method. Two basic conditions can lead to conflicts between NPV and IRR: timing size the cost of one project is larger than the other When mutually exclusive projects are considered, then the method should be used to evaluate projects. average project. Bellinger's WACC is
What is Project As IRR? Do not round intermediate calculations. Round your answer to tho decimal places.
What is Project Bs IRR? Do not round intermediate calculations. Round your answer to two decimal places.
If the projects were independent, which projects would be accepted according to the IRR method?
If the projects were mutually exclusive, which projects would be accepted according to the IRR method?
Could there be a conflict with project acceptance between the NPV and IRR approaches when projects are mutually exclusive?
The reason is select
Reinvestment at the
is the superior assumption, so when mutually exclusive projects are evaluated the Select approach should be used for the capital budgeting decision.
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