Net Present Value Approach

Question 1

Identify the advantages of the net-present-value approach to capital project evaluation.

Answer 1

• It uses the time value of money concept.
• It relates project rate of return to cost of capital.
• It considers the entire life and results of project.
• It is easier to compute than the internal rate of return approach.

Question 2

Identify the disadvantages of the net-present-value approach to capital project evaluation.

Answer 2

• It requires estimation of cash flows over entire life of the project, which could be very long.
• It assumes cash flows are immediately reinvested at the discount rate.

Question 3

Describe the net-present-value approach to capital project evaluation.

Answer 3

• It compares the present value of expected cash inflows of a project with cash outflows, including initial cash investment in project.
• It is derived by discounting future cash inflows (or savings) and determining whether or not the resulting present value is more or less than the present value of outflows, including cost of the investment.

Question 4

How is net present value determined?

Answer 4

It is the difference (net) between the present value of expected cash inflows from a project and expected cash outflows, including the initial cost of the project.

Question 5

Using the net-present-value approach (to capital budgeting), under what conditions would a project be considered economically feasible?

Answer 5

If the net present value is zero or positive, the project is considered economically feasible; otherwise, the project is not considered economically feasible.