Asked by Yesenia Lazarte on Jul 22, 2024
Verified
The net present value method assumes that the cash flows over the life of the project are reinvested at:
A) the project's internal rate of return.
B) the risk-free rate.
C) the market capitalization rate.
D) the firm's cost of capital.
Net Present Value
A financial metric that calculates the value of projected cash flows, discounted back to the present value.
Firm's Cost
The total expenses incurred by a company, including production, operation, and overhead costs.
Reinvestment Assumption
The presumption that cash flows received from an investment will be reinvested at a rate consistent with the investment's original rate of return.
- Differentiate the net present value (NPV) and internal rate of return (IRR) methods, and apprehend the instances in which they may yield varying conclusions.
- Appreciate the essentiality of a firm's cost of capital in scrutinizing investment proposals.
Verified Answer
RC
Rebekah CarverJul 23, 2024
Final Answer :
D
Explanation :
The net present value method assumes that the cash flows over the life of the project are reinvested at the firm's cost of capital. This is the appropriate assumption because the cost of capital represents the required rate of return for the firm's investors, and therefore is the cost of obtaining the funds necessary to undertake the project. By assuming that cash flows are reinvested at this rate, the net present value method takes into account the opportunity cost of using these funds for the project rather than in alternative investments that would offer the firm's investors the same return.
Learning Objectives
- Differentiate the net present value (NPV) and internal rate of return (IRR) methods, and apprehend the instances in which they may yield varying conclusions.
- Appreciate the essentiality of a firm's cost of capital in scrutinizing investment proposals.