In what types of situations would capital budgeting decisions be made solely on

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In what types of situations would capital budgeting decisions be made solely on the basis of project’s net present value (NPV)? Identify potential reasons that might drive higher NPV for a given project. Substantiate your response by providing an example to explain your thought process.
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Jun 20, 2024, 8:37 AM
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Clover CreightonJun 20, 2024, 10:43 PM
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Dr. Baker, Companies often use net present value as a capital budgeting method because it is a useful method to evaluate whether to invest in a new capital project. It is refined from both a mathematical and time-value-of-money point of view than either the payback period or discounted payback period methods. It is also more insightful in certain ways than the profitability index or internal rate of return calculations. 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 (Carlson, 2022). Net present value also has its own decision rules if the project is independent or mutually exclusive. Independent projects: If NPV is greater than $0, accept the project. Mutually exclusive projects: If the NPV of one project is greater than the NPV of the other project, accept the project with the higher NPV. If both projects have a negative NPV, reject both projects.
Situations that capital budgeting decisions are made solely based on a project’s NPV would be when a company has limited capital available for the investment and cannot fund all potential projects. So the deciding factor would be the project with the highest NPV. Another situation would be an independent project that have no affect or doesn’t compete with another project or if risk is being considered and equal between projects the higher NPV could be the deciding factor. Ways that NPV might be higher for a given project is if it is a larger project then naturally this would drive up the NPV because there is a direct relationship to sales (Gallant, 2024). Thank you for reading, Clover Creighton
Carlson, R. (2022, November 30). Net present value (NPV) as a capital budgeting method. The Balance. https://www.thebalancemoney.com/net-present-value-npv-as-a-capital-budgeting-method-392915
Gallant, C. (2024, April 17). Disadvantages of net present value (NPV) for investments. Investopedia. https://www.investopedia.com/ask/answers/06/npvdisadvantages.asp#:~:text=Investment%20Size&text=If%20there%20are%20two%20investments,result%20in%20a%20larger%20number.

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