21MBA1271

Megha Bhola

Corporate Finance

Q: EFG Ltd is considering two possible projects but can only raise enough funds to
proceed with one of them. Investment appraisal techniques have been used and the
following results found:

Which of the following is the most logical interpretation of the results?

A. Project W should be selected as it gives the longest payback period
B. Project W should be selected because it will yield the highest NPV
C. Project X should be selected because it will yield the lowest NPV
D. The ARR is the most meaningful investment appraisal technique and hence Project W
should be selected.

Explain.

Ans: B is the correct answer i.e., Project W should be selected

because it will yield the highest NPV. Net Present Value is a
metric that is able to determine whether or not an investment
opportunity is smart financial decision.

Net Present Value is one of many capital budgeting methods

used to evaluate potential physical asset projects in which a
company might want to invest. Usually, these capital investment
projects are large in terms of scope and money, such as
purchasing an expensive set of assembly-line equipment or
constructing a new building.

Net present value uses discounted cash flows in the analysis,

which makes the net present value more precise than of any of
the capital budgeting methods as it considers both the risk and
time variables.

A positive NPV indicates that the projected earnings generated

by a project or investment—in present dollars—exceeds the
 21MBA1271
Megha Bhola

anticipated costs, also in present dollars. It is assumed that an

investment with a positive NPV will be profitable.

A net present value analysis involves several variables and

assumptions and evaluates the cash flows forecasted to be
delivered by a project by discounting them back to the present
using information that includes the time span of the project (t) and
the firm's weighted average cost of capital. If the result is positive,
then the firm should invest in the project. If negative, the firm
should not invest in the project.

Net present value is the more commonly used method for

analyzing capital budgets. One of the reasons for its wider
acceptance is that NPV provides a more detailed analysis
compared to IRR calculations because it discounts individual cash
flows from a project separately. NPV is also the ideal option when
planners don't have a discount rate.

Here, in this case, EFG Ltd should select Project W as the NPV
technique is the most reliable investment appraisal technique.