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If the net present value of this proposal is greater than zero and the firm is not under the constraint of capital rationing, then the firm should:
calculate the IRR of this investment to be certain that the IRR is greater than the cost of capital.
compare the profitability index of the investment to those of other possible investments.
calculate the payback period to make certain that the initial cash outlay can be recovered within an appropriate period of time.
accept the proposal, since the acceptance of value-creating investments should increase shareholder wealth.
My answer is option (D) accept the proposal
I would add another comment to clarify the concept.
The NPV should have already be calculated using the WACC as discount rate, this includes by definition all the components that reward the shareholders over and above a risk free investment rate (RFR) + Equity Beta (levered) + Market Risk Premium (MPR) + if applicable Size Premium (SP) = Cost Of Equity (COE).
In essence the WACC already implies a value creation for the shareholders.
If the discount rate was different from the WACC (in case of investment proposals from one party to another), then the IRR should be calculated just as additional verification and the IRR should be equal or higher than the WACC in order to create shareholders wealth.
The calculation of the WACC is subject to much debate and scholarship so it is not, for some of its components, a straight forward process and might vary from party to party. So a prior agreement on the WACC figure saves a lot of time later.
>>>>> accept the proposal, since the acceptance of value-creating investments should increase shareholder wealth.
Option forth is answer ????????????????//
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accept the proposal, since the acceptance of value-creating investments should increase shareholder wealth......... . . .
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accept the proposal, since the acceptance of value-creating investments should increase shareholder wealth.
calculate the IRR of this investment to be certain that the IRR is greater than the cost of capital. The project which is less cost of capital then IRR will be considered for capital rationing purpose.
Correct Ans is :
Accept the proposal, since the acceptance of value-creating investments should increase shareholder wealth.>>>>>>>>>>>>>>>
In terms of considering a standalone investment proposal pertaining to the firm and accuracy of NPV calculation based on firm-wide WACC, the answer would ideally be the 4th.
