5. The net present value (NPV) method of investment project analysis assumes that the project's cash flows are reinvested at the
Answer(s): C
The NPV method is used when the discount rate is specified. It assumes that cash flows from the investment can be reinvested at the particular project's discount rate.
6. The rankings of mutually exclusive investments determined using the internal rate of return method (IRR) and the net present value method (NPV) may be different when
Answer(s): D
The two methods ordinarily yield the same results, but differences can occur when the duration of the projects and the initial investments differ. The reason is that the IRR method assumes cash inflows from the early years will be reinvested at the internal rate of return. The NPV method assumes that early cash inflows are reinvested at the NPV discount rate.
A firm with an 18% desired rate of return is considering the following projects (on January 1 1Year 1): Using the net-present-value (NPV) method, Project A's net present value is
The cash inflow occurs 5 years after the cash outflow, and the NPV method uses the firm's desired rate of return of 18%. The present value of $1 due at the end of 5 years discounted at 18% is .4371. Thus, the NPV of Project A is $(265,460) [($7,400,000 cash inflow x 4371) --$3,500,000 cash outflow].
A firm with an 18% desired rate of return is considering the following projects (on January 1, Year 1):Project B's internal rate of return is closest to
The internal rate of return is the discount rate at which the NPV is zero. Consequently, the cash outflow equals the present value of the inflow at the internal rate of return. The present value of $1 factor for Project B's internal rate of return is therefore 4020 ($4,000,000 cash outflow ÷ $9,950,000 cash inflow). This factor is closest to the present value of $1 for5 periods at 20%.
Amstar Corporation has not yet decided on its hurdle rate for use in the evaluation of capital budgeting projects. This lack of information will prohibit Amstar from calculating a project's
A hurdle rate is not necessary in calculating the accounting rate of return. That return is calculated by dividing the net income from a project by the investment in the project. Similarly, a company can calculate the internal rate of return (IRR) without knowing its hurdle rate. The IRR is the discount rate at which the net present value is $0. However, the NPV cannot be calculated without knowing the company's hurdle rate. The NPV method requires that future cash flows be discounted using the hurdle rate.
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