Question

Identify the simplifying assumptions usually made in net present value analysis. (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)
A. All cash flows other than the initial investment occur at the end of periods.unchecked
B. All cash flows generated by the investment project are immediately reinvested at a rate of return greater than the discount rate.unchecked
C. All cash flows generated by the investment project are immediately reinvested at a rate of return equal to the discount rate.unchecked
D. All cash flows occur at the beginning of the periods.unchecked
E. The time value of money is ignored when evaluating investment proposals under the net present value analysis.

Answer 1

Answer: A. All cash flows other than the initial investment occur at the end of periods.

C. All cash flows generated by the investment project are immediately reinvested at a rate of return equal to the discount rate.

Explanation:

The Net Present Value is one of the most popular Capital Budgeting methods used in Project analysis. It works by subtracting the cost of an investment from the present value of it's future cashflows.

One assumption it makes is that the cashflows occur at the end of each period. This allows for easier calculations as partial discounting will not be done but rather full discounting for the year.

Another key assumption it makes its that the cashflows generated from the project are reinvested at the Cost of Capital which is a rate of return equal to the discount rate. This is why all cashflows are discounted at this rate of return.