When Richard evaluated a capital budgeting project⎯a new machine needed to manufacture inventory⎯using his firm's required rate of return,he discovered that the project's net present value (NPV)is negative.Based on this information,which of the following must be correct?
A) The project's internal rate of return is also negative.
B) The project's discounted payback period is greater than its economic life.
C) As long as the new machine's initial investment outlay is fairly low,the firm should purchase if it is used to replace an older machine that is required to produce inventory.
D) The project's traditional payback period must be greater than the maximum payback period that the firm has established.
E) Two or more of these scenarios must be correct.

Question

Quizplus · Accepted Answer

A negative NPV indicates that the project does not generate sufficient return to cover its costs and required rate of return. Therefore, it is unlikely that the project has a positive internal rate of return, hence option A is incorrect. Option C is incorrect because the decision to replace an old machine should incorporate other factors such as maintenance costs, efficiency, and future demand. Option D may or may not be correct, but there is not enough information to determine the traditional payback period or the maximum payback period. Option B, however, is the only definitive statement that can be made since a negative NPV indicates that the discounted cash inflows do not cover the initial investment during the economic life of the project. Therefore, the discounted payback period is greater than the economic life.

When Richard Evaluated a Capital Budgeting Project⎯a New Machine Needed