CMA Study Group

 View Only
  • 1.  Par 2 Wiley

    Posted 09-23-2020 11:07 AM
    Can someone explain this answer to me? I don't understand how you can come up with this conclusion. Am I missing something? The answer in Bold is what they are saying is correct.

    Question 12
     
    tb.risk.analy.cap.qi.001_1712
    Leigh Inc. is evaluating two potential investment opportunities. The total net cash inflows and payback period are the same for both potential projects. Leigh's management can conclude that:
    This answer is correct because the timing of the net cash inflows impacts NPV. While the total net cash inflows are the same for the two projects, the timing of the cash flows may differ. For example, assume that both projects cost $90,000 and have a three-year payback period. Project A's estimated net cash inflows are Year 1: $50,000, Year 2: $30,000, and Year 3: $10,000; whereas, Project B's net cash inflows are estimated as Year 1: $35,000, Year 2: $40,000, and Year 3: $15,000. In this case, the total net cash inflows and payback period are the same for both projects. However, the time value of money would result in different values for NPV and once all cash flow elements are included, the NPV of the two projects could be significantly different.


    ------------------------------
    Judi Aldridge
    Unemployed
    Philadelphia PA
    United States
    ------------------------------


  • 2.  RE: Par 2 Wiley

    Posted 09-24-2020 05:24 AM
    "One project may have a positive net present value while the other project's NPV is negative"

    The question said that the 2 projects have the same Cash inflow (did not say the cash flows are discounted, so they are undiscounted cash flow by default)

    I show herein an example for the scenario that 2 projects have the same (undiscounted) cash inflow; even same (undiscounted) Cash outflow and same length of time. But result in different NPV:
                        Y0        Y1       Y2        Y3       Y4
    Project 1  -1,000    +200    +300   +400       0
    Project 2        0       +200    +300   +400  -1,000 

    It is clear that the (undiscounted) Net cash flows, cash inflows and outflows are very the same in the 2 projects. Then, you may add the"time value of money" element to evaluate the project. Because, an amount of money in the future will be less valuable than the same amount at the present time

    Try to discount the cash flow and calculate NPV for both projects at any discount rate. You'll see

    A. is incorrect. Because, you can see the scenario that proves it wrong in given example
    B. is incorrect. Because, they are ranked differently due to the scenario above
    C . is incorrect. Check my example above

    "One project may have a positive net present value while the other project's NPV is negative" is correct. 

    There is a tip that any choice contains adverbs: "must, always, will" take a very high chance to be wrong. It is a tip for candidates who take IELTS and CMA too. Because, it is relatively difficult to prove a certain idea is correctly applied for any case