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d. If the opportunity cost of capital is 10%, which projects have positive NPVs? e. “If a firm uses a single cutoff period for all projects, it is likely to accept too many shortlived projects." True or false?

d. If the opportunity cost of capital is 10%, which projects have positive NPVs? e. “If a firm uses a single cutoff period for all projects, it is likely to accept too many shortlived projects." True or false?

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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### NPV Analysis and Cutoff Periods in Project Evaluation When evaluating potential investment projects, understanding the concepts of Net Present Value (NPV) and the implications of using uniform cutoff periods is crucial. Below are considerations and questions often faced in capital budgeting: **d. If the opportunity cost of capital is 10%, which projects have positive NPVs?** To determine if a project has a positive NPV at an opportunity cost of capital of 10%, you will need to compare each project's rate of return with this threshold. Only projects yielding a return higher than 10% will result in positive NPV, signifying that the project's expected earnings exceed the capital's cost. **e. “If a firm uses a single cutoff period for all projects, it is likely to accept too many short-lived projects.” True or false?** Using a single cutoff period for assessing all projects might lead the firm to favor short-term projects. This is because short-lived projects can quickly satisfy the cutoff period criteria while potentially neglecting long-term projects that, though taking longer to pay back, could ultimately offer higher returns. This statement can be considered generally true; it points to a potential bias inherent in using a uniform cutoff period. Understanding these principles is essential for making informed investment decisions that align with the firm's financial goals.
Transcribed Image Text:### NPV Analysis and Cutoff Periods in Project Evaluation When evaluating potential investment projects, understanding the concepts of Net Present Value (NPV) and the implications of using uniform cutoff periods is crucial. Below are considerations and questions often faced in capital budgeting: **d. If the opportunity cost of capital is 10%, which projects have positive NPVs?** To determine if a project has a positive NPV at an opportunity cost of capital of 10%, you will need to compare each project's rate of return with this threshold. Only projects yielding a return higher than 10% will result in positive NPV, signifying that the project's expected earnings exceed the capital's cost. **e. “If a firm uses a single cutoff period for all projects, it is likely to accept too many short-lived projects.” True or false?** Using a single cutoff period for assessing all projects might lead the firm to favor short-term projects. This is because short-lived projects can quickly satisfy the cutoff period criteria while potentially neglecting long-term projects that, though taking longer to pay back, could ultimately offer higher returns. This statement can be considered generally true; it points to a potential bias inherent in using a uniform cutoff period. Understanding these principles is essential for making informed investment decisions that align with the firm's financial goals.
# Cash Flow Analysis for Different Projects The cash flow table below represents the cash inflows and outflows for three different projects (A, B, and C) over a five-year period. Each column indicates the cash flow at the end of the corresponding year. ## Cash Flows ($) | Project | \( C_0 \) | \( C_1 \) | \( C_2 \) | \( C_3 \) | \( C_4 \) | |---------|-----------|-----------|-----------|-----------|-----------| | **A** | –5,000 | +1,000 | +1,000 | +3,000 | 0 | | **B** | –1,000 | 0 | +1,000 | +2,000 | +3,000 | | **C** | –5,000 | +1,000 | +1,000 | +3,000 | +5,000 | * \( C_0 \) represents the initial investment. * \( C_1 \), \( C_2 \), \( C_3 \), and \( C_4 \) represent the cash flows for years 1, 2, 3, and 4 respectively. ### Explanation: - **Project A**: Starts with an initial investment of -$5,000. It generates cash inflows of $1,000 in the first and second year, $3,000 in the third year, and no cash flow in the fourth year. - **Project B**: Requires a smaller initial investment of -$1,000. There is no cash flow in the first year, followed by a $1,000 inflow in the second year, $2,000 in the third year, and $3,000 in the fourth year. - **Project C**: Has an initial investment identical to Project A, -$5,000. It brings in a $1,000 cash inflow in the first and second years, a $3,000 inflow in the third year, and a $5,000 inflow in the fourth year. The information provided in this table can be used to compare the investments and returns for different projects over a specific time period, helping in decision-making processes.
Transcribed Image Text:# Cash Flow Analysis for Different Projects The cash flow table below represents the cash inflows and outflows for three different projects (A, B, and C) over a five-year period. Each column indicates the cash flow at the end of the corresponding year. ## Cash Flows ($) | Project | \( C_0 \) | \( C_1 \) | \( C_2 \) | \( C_3 \) | \( C_4 \) | |---------|-----------|-----------|-----------|-----------|-----------| | **A** | –5,000 | +1,000 | +1,000 | +3,000 | 0 | | **B** | –1,000 | 0 | +1,000 | +2,000 | +3,000 | | **C** | –5,000 | +1,000 | +1,000 | +3,000 | +5,000 | * \( C_0 \) represents the initial investment. * \( C_1 \), \( C_2 \), \( C_3 \), and \( C_4 \) represent the cash flows for years 1, 2, 3, and 4 respectively. ### Explanation: - **Project A**: Starts with an initial investment of -$5,000. It generates cash inflows of $1,000 in the first and second year, $3,000 in the third year, and no cash flow in the fourth year. - **Project B**: Requires a smaller initial investment of -$1,000. There is no cash flow in the first year, followed by a $1,000 inflow in the second year, $2,000 in the third year, and $3,000 in the fourth year. - **Project C**: Has an initial investment identical to Project A, -$5,000. It brings in a $1,000 cash inflow in the first and second years, a $3,000 inflow in the third year, and a $5,000 inflow in the fourth year. The information provided in this table can be used to compare the investments and returns for different projects over a specific time period, helping in decision-making processes.
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