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Accountant

In: Business and Management

Submitted By ealyce84
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Net Present Value Method

As applied to the analysis of one potential investment, if the cost of an asset investment is less than the present value of the net future cash flows estimated to result from purchase of that asset, then the investment’s return is greater than the firm’s cost of capital. In addition it is true that the Net Present Value is positive.

Generally if the NPV dollar amount is positive, the proposed investment is acceptable. Again, the investment’s return is > the firm’s cost of capital. The cost of the asset is less than the present value of the estimated net future cash flows the company expects to get from purchasing this asset.

If the NPV is negative, the proposed investment should be rejected because the investment’s return is less than the firm’s cost of capital, and the cost of the asset is greater than the present value of the net future cash flows.

Please note that something is wrong with one’s analysis if the NPV is positive but the cost of capital is shown to be greater than the rate of return. This would not make sense. Similarly, it would not make sense if the NPV is negative, but the rate of return is shown as being greater than the cost of capital.

To recap:
A capital investment generates a satisfactory rate of return when its return is greater than or equal to the firm’s cost of capital. The weighted average cost of a firm’s debt and equity financing is defined as the firm’s cost of capital. Know how to compute cost of capital for the quiz and big

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