Question

Brunette Company is contemplating investing in a new piece of manufacturing machinery. The amount to be invested is $180,000. The present value of the future cash flows generated by the project is $163,000. Should they invest in this project?
A) no, because the rate of return on the project is less than the desired rate of return used to calculate the present value of the future cash flows
B) no, because net present value is +$17,000
C) yes, because the rate of return on the project is equal to the desired rate of return used to calculate the present value of the future cash flows
D) yes, because the rate of return on the project exceeds the desired rate of return used to calculate the present value of the future cash flows

Answer 1

Answer:

A) no, because the rate of return on the project is less than the desired rate of return used to calculate the present value of the future cash flows

Explanation:

The NPV is calculated by subtracting the initial investment from the Present value of the project's future cashflows;

NPV = 163,000 - 180,000

NPV = -17,000 , this eliminates choice B

NPV and IRR rule always agree on the decision to accept or reject a project so long as the pattern of cashflows is the same.

Since, the NPV is negative, this project will be rejected. For IRR rule to agree with this, the internal rate of return will also be less than the discount rate used to calculate the present value of future cashflows, making choice A correct.