Which capital budgeting method is most useful for evaluating a project that has an initial after-tax cost of $5,000,000 and is expected to provide after-tax operating cash flows of $1,800,000 in year 1, ($2,900,000) in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?
A) net present value
B) internal rate of return
C) payback
D) accounting rate of return

Question

Quizplus · Accepted Answer

The most useful capital budgeting method for evaluating this project is the net present value (NPV) method. This is because the NPV takes into account the time value of money, which is important for evaluating cash flows that occur at different points in time. Using the given cash flows and a discount rate, the NPV can be calculated to determine if the project is expected to generate a positive or negative return. A positive NPV indicates that the project is expected to be profitable and is worth pursuing, whereas a negative NPV indicates that the project is expected to lose money and should be rejected. The other methods, such as payback and accounting rate of return, do not take into account the time value of money and may not provide an accurate representation of the project's true profitability. The internal rate of return (IRR) may also be useful for evaluating the project, but the NPV provides a more complete picture and is often the preferred method.

Which Capital Budgeting Method Is Most Useful for Evaluating a Project