Chapter 24, Problem 6MCQ

To determine

The correct option that determines the best method to select the best project based on cost-benefit analysis.

Answer to Problem 6MCQ

Option c is correct.

Explanation of Solution

Explanation for the correct option:

c.

While selecting one project among various alternatives, one should determine the net value of the project. Net present value can be determined by subtracting the present value of inflows and the present value of outflows. The project with maximum NPV will generate higher revenue as compared to the investment made. Therefore, option c is correct.

Explanation for incorrect options:

a.

If a project’s present value of cash inflows is maximum without knowing the initial investment then the best project cannot be determined. Therefore, option a is incorrect.

b.

If the future value of the cash inflows o Project A is the highest among all other projects then it cannot be termed as best as the initial investment is not discounted. Therefore, option b is incorrect.

d.

If the interest rate or the discount rate of a project is the highest then it cannot be termed as the best project because after a certain discounting rate the value of the project’s net cash flows starts deteriorating. Therefore, option d is incorrect.

e.

Both need to be considered i.e. project’s cost and the project’s cash inflows are required to determine the best project. Therefore, option e is incorrect.

Economics Concept Introduction

Interest rates: The rates that were charged by the investor who is ready to lend his/her money for a certain period of time to the borrower.

Present value of money: This is the concept that is used by every investor or financial dealer where the value of the dollar received today is compared with the value of the dollar that is expected to be received later by using interest rates.