In capital budgeting, when is a project considered acceptable based on Net Present Value (NPV)?

In capital budgeting, when is a project considered acceptable based on Net Present Value (NPV)?

• A. NPV should be positive
• B. NPV should be negative
• C. NPV should be zero
• D. NPV is irrelevant

Answer: (A)

NPV measures the value a project adds to the firm by discounting its expected cash inflows and outflows at the required rate of return. When the NPV is positive, the project earns more than the cost of capital, so it creates wealth for shareholders and should be pursued. If NPV were negative, the project would destroy value because its returns don’t meet the hurdle rate. If NPV is zero, the project just covers the cost of capital with no excess value created, so many managers are indifferent. The decision key is that only a positive NPV indicates a net gain after accounting for the time value of money, risk, and capital cost.

NPV measures the value a project adds to the firm by discounting its expected cash inflows and outflows at the required rate of return. When the NPV is positive, the project earns more than the cost of capital, so it creates wealth for shareholders and should be pursued. If NPV were negative, the project would destroy value because its returns don’t meet the hurdle rate. If NPV is zero, the project just covers the cost of capital with no excess value created, so many managers are indifferent. The decision key is that only a positive NPV indicates a net gain after accounting for the time value of money, risk, and capital cost.