Business Finance Homework Help

Part One:

Net Present Value (NPV) analysis is a tool for evaluating projects. It is calculated by;

1) estimating all incremental cash flows for a project, positive and negative, including the initial investment.

2) estimating the risk of the project.

3) discounting to the present, all the cash flows, at the rate appropriate for the risk (the COST OF CAPITAL). The general rule is; accept all projects with a positive NPV, reject all projects with a negative NPV. NPV will, in most cases, be the best tool to analyze long term projects.

Now, suppose that two companies are looking at the same project.

Company “A” has a beta of 1.5 and a cost of capital of 25%.

Company “B” has a beta of 0.8 and a cost of capital of 15%.

When evaluated at a rate of 15%, the project shows an NPV of +$5 million, and when evaluated at a rate of 25%, the project shows an NPV of -$2 million.
Should either company accept the project, and if so, under what conditions?

Part Two:

The general rule is that firms should adopt positive NPV projects, and reject negative NPV projects. But what if a project has a $0 NPV? Should they accept the project or reject it? Explain.

Part Three:

Read the article on “The fundamental problem with using NPV in project evaluation”.

http://shubhangshankar.blogspot.com/2007/08/fundam…

The author presents three key reasons on why managers prefer using IRR over NPV. Of these three, which do you feel is his best argument and why?

Part Four:

Watch the video on estimating cash flows. https://www.coursera.org/lecture/wharton-decision-…

Which of the three (Initial Investment Cash Flow, and Terminal Cash Flow) do you think is the most difficult to estimate in practice?