A project has a positive NPV when its cash flows are discounted at the company's cost of capital. What does this tell management?
Answer and explanation
Correct answer: C. The project is expected to earn more than the required return and add value to the company
- Step 1: NPV discounts all future cash flows at the required return.
- Step 2: A positive NPV means the cash flows more than cover the required return.
- Step 3: The IRR will then exceed the cost of capital.
Answer
The project is expected to earn more than the required return and add value to the company.
Why not the others: NPV says nothing about the speed of payback. NPV is based on cash flows and not on accounting profit. A positive NPV means the IRR is higher than the cost of capital.
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