In capital budgeting the NPV method is used to rank investment projects based

# In capital budgeting the npv method is used to rank

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In capital budgeting, the NPV method is used to rank investment projects based on their profitability. The NPV method is the primary capital budgeting decision-making tool to analyze whether an investment project should be undertaken or rejected. To determine if an investment project should be undertaken, we need to discount the future cash flows expected to be generated by this project to the present value using the project’s cost of capital or hurdle rate. When a company decides to invest in a new project, they would usually incur in several initial investment costs (cash outflows) followed by a series of positive cash flows (cash inflows). For practical purposes, we will assume that a company will make a initial cash outflow or initial investment in year 0. This cash outflow in year 0 will be added to the sum of the present value of the future cash flows of the project to obtain the NPV. Since the future cash flow generated from a project will tend to vary, we will calculate the present value of each cash flow individually. For example, suppose that Coors Co. has been presented with two investment projects to build a new brewing plant in Boise, Idaho. Project A & B have different expected cash flows. We assume that these two projects have the same risk and all the cash flows from these projects occur at the end of each year. Also, both projects have the same cost of capital, 10%. The cash flows of Project A&B are presented as follows: Expected net cash flows Year Project A Project B 0 (\$1,000) (\$1,000) 1 \$400 \$500 2 \$300 \$350 3 \$500 \$400 4 \$200 \$695