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The cost of capital is inversely proportional to the NPV.
As capital costs increase (i.e. the interest rate increases), NPV decreases.
As capital costs decrease (i.e. the interest rate decreases), NPV increases.
You can see the relationship in the following equation:
NPV = a * ((1+r)^y - 1)/(r * (1+r)^y)
Where:
NPV = Net Present Value (The present value of a future amount, before interest earnings/charges)
a = Amount received per year
y = Number of years
r = Present rate of return
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What happens to NPV when cost of capital increased?
NPV decreases when the cost of capital is increased.
Why the NPV of a relatively long term project is more sensitive to changes in the cost of capital than is the NPV of a short term project?
due to the uncertainty
The NPV assumes cash flows are reinvested at the?
The NPV assumes cash flows are reinvested at the: A. real rate of return B. IRR C. cost of capital D. NPV
If the opportunity cost of capital for a project exceeds the projects IRR then the project has a NPV negative?
If the opportunity cost of capital for a project exceeds the Project's IRR, then the project has a(n)
Would NPVs change if the WACC changed?
Yes, NPVs would change if the Weighted Average Cost of Capital (WACC) changed. A higher WACC would result in a lower NPV, while a lower WACC would result in a higher NPV. This is because the discount rate used in calculating NPV is based on the WACC.
Calculate rate of return?
NPV/Initial Cost of Investment
How are projects selected under capital rationing?
on the basis of projects having higher npv
How do you make capital budgeting?
by considering npv analysis , irr and pay back period
What are the Similarities between NPV and IRR?
They explain the time value of money 􀂃 Both useful in capital budgeting and investment valuation
What is the effect on IRR if cost of capital decreased?
A change in the cost of capital will not, typically, impact on the IRR. IRR is measure of the annualised effective interest rate, or discount rate, required for the net present values of a stream of cash flows to equal zero. The IRR will not be affected by the cost of capital; instead you should compare the IRR to the cost of capital when making investment decisions. If the IRR is higher than the cost of capital the project/investment should be viable (i.e. should have a positive net present value - NPV). If the IRR is lower than the cost of capital it should not be undertaken. So, whilst a higher cost of capital will not change the IRR it will lead to fewer investment decisions being acceptable when using IRR as the method of assessing those investment decisions.
Equipment A has a cost of Rs75000 and net cash flow of Rs20000 per year for six years A substitute equipment B would cost Rs50000 and generate net cash flow of Rs14000 per year for six years?
Equipment A NPV = 75000 - 120000 = 45000 Equipment B NPV = 50000 - 84000 = 34000 Based on NPV Equipment A should be selected
Difference between Sensitivity analysis and Scenario analysis?
Scenario Analysis: What happens to the NPV unde different cash flow scenarios? this analysis has: 3 dimensions to measure 1. Best case: High revenues, low cost 2. Worst case: low revenues, high cost 3. Base case: calculation with the given data Measure of the range of possible outcomes Best and Worts are not necessarily probable, but they can still be possible Sensitivity Analysis: What happnes to NPV when we vary one variable at a time? This is a subset of scenario analysis where we are looking at the effect of speciic variables on NPV The greater the volatility on NPV in relation to a specific variable, the larger the forecasting risk associated with that variable, and the more attention we want to pay to its estimation i.e. number of scenario analysis done, let's say 1,000 of different NPV, and the empirical distribution made us better off. Because we have observe the how volatile is the NPV.
