Question

The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions. Consider this case: Suppose Celestial Crane Cosmetics is evaluating a proposed capital budgeting project (project Beta) that will require an initial investment of $3,225,000. The project is expected to generate the following net cash flows: Year Year 1 Year 2 Year 3 Year 4 Cash Flow $375,000 $475,000 $425,000 $500,000 Celestial Crane Cosmetics's weighted average cost of capital is 7%, and project Beta has the same risk as the firm's average project. Based on the cash flows, what is project Beta's NPV? 0 O 0 -$1,731,275 $1,493,725 -$1,990,966 -$1,356,275 Making the accept or reject decision Celestial Crane Cosmetics's decision to accept or reject project Beta is independent of its decisions on other projects. If the firm follows the NPV method, it should project Beta.

Answer 1

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=375,000/1.07+475,000/1.07^2+425,000/1.07^3+500,000/1.07^4

=1493724.89

NPV=Present value of inflows-Present value of outflows

=1493724.89-3,225,000

=($1731275)(Approx)(Negative).

Hence since NPV is negative;project must be rejected.