The primary reason that company projects with positive net present values are considered acceptable is that:
the required cash inflows exceed the actual cash inflows
they create value for the owners of the firm
they have advantages compared with other methods
Net present value
cannot be used when deciding between two mutually exclusive projects.
is not as widely used in practice as payback and discounted payback
is more useful than the internal rate of return when comparing different sized projects.
Payback is frequently used to analyze independent projects because:
discounting of all cash flows
it is easy and quick to calculate
all relevant cash flows are included in the analysis
The internal rate of return for investment project:
is used primarily to rank projects of varying sizes
is the rate generated solely by the cash flows of the investment
is the rate that causes the net present value of a project to equal the project’s initial cost
The internal rate of return tends to be:
extremely accurate even when cash flow estimates are faulty.
ignored by most financial managers
easier for managers to comprehend than the net present value.
The profitability index:
method is most commonly used when deciding between mutually exclusive projects of varying size
is useful as a decision tool when investment funds are limited and all available funds are allocated
produces results which typically are difficult to comprehend
What is the net present value of a project with an initial cost of $36,900 and cash inflows of $13,400, $21,600, and $10,000 for Years 1 to 3, respectively? The discount rate is 10 percent.
Aniv is reviewing a project with an initial cost of $38,700 and cash inflows of $9,800, $16,400, and $21,000 for Years 1 to 3, respectively. Should the project be accepted if it has been assigned a required return of 9.75 percent? Why or why not?
no; because the IRR exceeds the required return by .43 percent
no; because the IRR is lower than the required return by .35 percent
yes; because the IRR exceeds the required return by .34 percent