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Chapter 26: Q23RQ (page 1464)

What is the decision rule for NPV?

Short Answer

Expert verified

Net present value (NPV) can be calculated by taking the sum of the discounted cash flows and subtracting it from the initial investment. The discounted cash flows are determined using the discounting factor and the current value. The investment project should permit it if the NPV is positive; however, if it is negative, the investment project should not permit it.

Step by step solution

01

Definition

Net present value comes after subtracting the total current value of all future cash flows from initial investment. It is employed for investment decision-making and capital budgeting purposes.

02

Advantages of NPV

The advantage of the net present value method is that this method considers the fact of the time value of money. A further period of capital expenditure is constantly added to the cash flows to reduce them.

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Most popular questions from this chapter

Refer to Short Exercise S26-4. Continue to assume that the expansion has no residual value. What is the project鈥檚 IRR? Is the investment attractive? Why or why not?

Question: Defining capital investment terms

Fill in each statement with the appropriate capital investment analysis method:

Payback, ARR, NPV, or IRR. Some statements may have more than one answer.

  1. _____ is (are) more appropriate for long-term investments.
  2. _____ highlights risky investments.
  3. _____ shows the effect of the investment on the company鈥檚 accrual-based income.
  4. _____ is the interest rate that makes the NPV of an investment equal to zero.
  5. _____ requires management to identify the discount rate when used.
  6. _____ provides management with information on how fast the cash invested will be recouped.
  7. _____ is the rate of return, using discounted cash flows, a company can expect to earn by investing in the asset.
  8. _____ does not consider the asset鈥檚 profitability.
  9. _____ uses accrual accounting rather than net cash inflows in its computation.

S26-2 Using payback to make capital investment decisions

Carter Company is considering three investment opportunities with the following payback periods:

Project A

Project B

Project C

Payback period

2.7 years

6.4 years

3.8 years

Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal.

How is payback calculated with unequal net cash inflows?

Using the payback method to make capital investment decisions

Refer to the Hunter Valley Snow Park Lodge expansion project in Short Exercise S26-4. Compute the payback for the expansion project. Round to one decimal place.

See all solutions

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