The Net Present Value rule states that when making an investment decision, choose the project with the highest NPV. If the objective is to maximize wealth, then “the NPV rule always gives the correct answer (Berk and DeMarzo, 2011).” According to the text, we use the NPV rule to evaluate capital budgeting decisions, making decisions that maximize NPV (Berk and DeMarzo, 2011). Determining which projects to accept or reject is based on whether or not the project has a positive NPV. NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. Based upon the principle of this rule, a project with a positive NPV is accepted because it ensures that the future value of that same dollar will be greater. The following scenario is provided to evaluate Bauer Industries’ project to manufacture lightweight trucks.
Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental free cash flow projections (in millions of dollars):
