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Homework answers / question archive / Assume that your organization's CFO has just completed a presentation to the board of trustees concerning the analysis of a proposed ambulatory surgery center costing $2 million
Assume that your organization's CFO has just completed a presentation to the board of trustees concerning the analysis of a proposed ambulatory surgery center costing $2 million. During the presentation, the CFO indicated that the project had an NPV of $786,339 and an IRR of 17.3 percent. Based on its risk, the project was judged to have a cost of capital of 13 percent. Which of the following statements is most correct?
A. The project is financially acceptable because its NPV is positive.
B. The project is financially acceptable because its IRR is greater than zero.
C. The project is financially unacceptable because its NPV is less than the project's initial investment cost.
D. The project is financially unacceptable because its IRR is greater than its cost of capital.
E. The project is financially unacceptable, but it may have sufficient social value to make it worthwhile.
Answer:
A. The project is financially acceptable because its NPV is positive.
Explanation:
~ While making a decision on a capital budgeting problem, the most appropriate measure to decide is on the basis of NPV of the project.
~ If the NPV is positive, then the project will be profitable, because positive NPV means its present value of cash inflows is greater than the initial investment cost. Hence, if the project has a positive NPV, then the project is acceptable.
~ In this case the project has a positive NPV of $786,339. Therefore, option A. is correct.
~ For IRR, the decision rule is that if the IRR > cost of capital, then the project is acceptable. In this case, the project is acceptable because IRR is greater than cost of capital. Therefore, option B and D are incorrect.
~ Option C is incorrect because for a project to be acceptable, NPV should be positive, not necessarily greater than the initial investment. Option E is incorrect because social factors are not considered for checking if project is financially acceptable or not.
