Net Present Value Approach

Question 1

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

Answer 1

Requires estimation of cash flows over entire life of the project, which could be very long.
Assumes cash flows are immediately reinvested at the discount rate.

Question 2

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

Answer 2

If the Net Present Value is zero or positive, the project is considered economically feasible; otherwise, the project is not considered economically feasible.

Question 3

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

Answer 3

1. Uses time value of money concept
2. Relates project rate of return to cost of capital
3. Considers entire life and results of project
4. Easier to compute than internal rate of return approach

Question 4

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

Answer 4

Compares present value of expected cash flows of project with initial cash investment in project.
Derived by discounting future cash flows (or savings) and determining whether or not the resulting present value is more or less than the cost of the investment.

Question 5

How is the Net Present Value determined?

Answer 5

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