Q: When a project npv exceeds zero?

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Response by R. NowaidResponse to the Caledonia Products Integrative ProblemProject ranking is prioritizing projects based on a project's stream of cash flow by measuring net present value (NPV), the internal rate of return (IRR), and Macaulay duration that is calibrated based on cash-flow timing. Conflict of ranking arises when managers have to make subjective decisions due to organizational goals and needs. In a mutually exclusive projects three factors remain as key ranking elements; (1) size disparity; (2) time disparity; and (3) unequal lives.Size Disparity"The size disparity problem occurs when mutually exclusive projects of unequal size are examined." In the case for Caledonia Products, Project A and B may have the same initial investment amount; however, cash inflow of Project A begins in the first year but Project B begins in the fourth year. Both projects vary on net to present value, internal rate of return, and profitability index. If size disparity causes conflicting ranking among mutually exclusive projects, then the project with the largest net present value is considered; given the fact that there would be no capital rationing. Standing alone on this criteria, Project B is more viable because total NPV of Project B is higher that Project A.Time Disparity"The time disparity problem and the conflicting rankings that accompany it result from the differing reinvestment assumptions made by the net present value and internal rate of return decision criteria." In case of Caledonia Products, total cash flow at the fifth year for Project A is $40,000 less than Project B's, NPV for Project A is less than Project B's. Project A begins cash inflow at the first year, the payback period for Project A is 3.125 years versus 4.5 years for Project B, and IRR for Project A is 18.03% versus Project B's IRR is 14.87%. Assuming that cash inflow during life of project can be reinvested, that would make Project A to be more viable.Unequal LivesUsing size and time disparities in conjunction with NPV and IRR may lead to conflicting results in analyzing mutually exclusive projects. A primary cause of conflicting ranking can be timing of the cash flows of the mutually exclusive projects. In the case of Caledonia Products, Project B may have higher total cash flow at maturity and NPV of Project B may be higher as well; however, Project A makes cash available now. Knowing cash is king, and Project A's cash inflow begins in the first year versus Project B's cash inflow that begins in the fifth year, and this feature would make Project A more attractive.AnalysisInitial net investment in Project A and Project B are equal; however, total cash flow for Project A is $40,000 less than Project B's total cash flow and NPV for Project A is less than Project B's NPV.Considering aforementioned facts one manager may consider Project B because it has greater NPV and total Project cash value; however, Project A has one main incentive, on-going cash flow throughout the Project. Project A generates continues cash flow through the life cycle of the Project; whereas, Project B requires the organization to operate without incoming cash flow until the Project is completed.Conclusively, if the organization is in need of cash to maintain profitable operation by avoiding external financing and loan, then Project A makes most sense; however, if the organization is not in need of immediate cash, then Project B is a better decision. For example, a small construction company needs continues cash inflow to prevent expensive financing of project. On the other hand, a major meatpacking firm, which does not have cash flow problem, may wait to the delivery date to collect all its funds at a greater amount.

Your company is considering a project that will cost $1 million.The project will generate after-tax cash flows of $250,000 per year for 7 years. The WACC is 15% and the firm's target D/E ratio is .6 The flotation cost for equity is 5% and the flotation cost for debt is 3%. What is the NPV for the project after adjusting for flotation costs? fA = (E/V) x fE + (D/V) x fD fA = (.375)(3%) + (.625)(5%) = 4.25% PV of future cash flows = 1,040,105 NPV = 1,040,105 -1,000,000/(1-.0425) = -4,281

Advantages: a. It will give the correct decision advice assuming a perfect capital market. It will also give correct ranking for mutually exclusive projects. b. NPV gives an absolute value. c. NPV allows for the time value fo the cash flows. Disadvantages: a. It is very difficult to identify the correct discount rate. b. NPV as method of investment appraisal requires the decision criteria to be specified before the appraisal can be undertaken.

How is the method superior to the payback method

Related questions

If the opportunity cost of capital for a project exceeds the Project's IRR, then the project has a(n)

less than zero, greater than the requred return

If the net present value (NPV) of a project is zero, it means that the project is expected to generate exactly enough cash flows to cover the initial investment and provide the required rate of return. At an NPV of zero, the project's benefits equal its costs, indicating that it is neither creating nor destroying value for the organization. In this case, the decision to proceed with the project would depend on other factors such as strategic alignment, risk considerations, and potential qualitative benefits.

due to the uncertainty

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IRR: Internal rate return NPV: Net present value Both are measure of the viability of a project(s) You can have multiple IRR (because of discontinued cash flows) but you always have one NPV.

why investment in financial market have zero NPV? where as firms can find many investments in their product markets with positive NPVs.

Positive NPV

On average, the only return that is earned is the required return-investors buy assets with returns in excess of the required return (positive NPV), bidding up the price and thus causing the return to fall to the required return (zero NPV); investors sell assets with returns less than the required return (negative NPV), driving the price lower and thus the causing the return to rise to the required return (zero NPV).

Your firm is considering a project that will cost $4.55 million upfront, generate cash flows of $5 million per year for three years, and then have a cleanup and shutdown cost of $6 million in the fourth year. Assume a discount rate of 10% per annum, what is the NPV of this project? a. None of the other answers are true. b. The NPV of this project is $3.44 million. c. The NPV of this project is $3.34 million. d. The NPV of this project is $10.89 million.

Problems with project ranking: 1. Mutually exclusive projects of unequal size (the size disparity problem) - the NPVdecision may not agree with the IRR or PI. Solution: select the project with the larges NPV (not IRR). 2. The time disparity problem with mutually exclusive projects - NPV and PI assume cash flows are reinvested at the required rate of return for the project. IRR assumes cash flows are reinvested at the IRR. NPV decision may not agree with the IRR. Solution: select the project with the largest NPV. A good method to evaluate and rank project better is to use the Equivalent Annual Annuity (EAA) method. This is like calculating for PMT when doing TVM. It simply means, you will be getting that amount as an inflow each year or period. Therefore, you would want to choose the highest figure.

Yes, The PI and NPV always give the same decisions to accept or reject the projects. The Project's PI will be greater than 1.00 if the NPV is positive and PI will be less than 1.00 if the NPV is negative