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Suppose that an analyst makes a mistake and calculates the NPV of an investment project by discounting

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Suppose that an analyst makes a mistake and calculates the NPV of an investment project by discounting the projects contribution to net income each year rather than by discounting its relevant cash flows. Would you expect the NPV based on net in-come to be higher or lower than the NPV calculated using the relevant cash flows?
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NPV based on net income could be higher if the company has l...View the full answer


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Introduction to Corporate Finance

Introduction to Corporate Finance

ISBN: 978-0324657937

2nd edition

Authors: Scott B. Smart, William L Megginson

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NPV stands for \"Net Present Value,\" which is a financial concept used to determine the value of an investment or project. It measures the difference between the present value of cash inflows and the present value of cash outflows over a given period of time, using a specific discount rate. To calculate the NPV of an investment, you need to first estimate the cash inflows and outflows associated with the investment, and then discount them back to their present values using a discount rate. The discount rate represents the cost of capital or the expected rate of return required by investors. The formula for calculating NPV is: NPV = sum of (cash inflows / (1 + discount rate)^t) - sum of (cash outflows / (1 + discount rate)^t) Where: Cash inflows: the expected cash received from the investment Cash outflows: the expected cash paid out for the investment Discount rate: the required rate of return or the cost of capital t: the time period in which the cash flow occurs If the NPV is positive, it means that the investment is expected to generate a return higher than the required rate of return or the cost of capital, and it may be considered a good investment. If the NPV is negative, it means that the investment is not expected to generate a return higher than the required rate of return or the cost of capital, and it may be considered a bad investment.

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