Question

Which one of the following correctly describes the relationship between the NPV and discount rate?A)The higher the discount rate, the more likely a company will accept a potential capital budgeting project.B)The higher the discount rate, the higher the NPV of a cash flow. C)The higher the discount rate, the lower the NPV of a cash flow. D)Firms use a lower discount rate to evaluate riskier projects.

Answer 1

Answer:

C) The higher the discount rate, the lower the NPV of a cash flow.

Explanation:

Net Present Value (NPV) is the net value of discounted cash flows taken together, whether inflow or outflow.

It is discounted on the specified rate of interest of discount.

Now higher the rate lower will be NPV

For instance cash flow = $10,000 at each year end

Interest rate = 10% and 15%

Value at first year end in both cases will be,

At 10% = $\frac{1}{(1 + 0.1)^1} \times 10,000 = 9,091$

At 15% = $\frac{1}{(1+0.15)^1} \times 10,000 = 8,696$

Now higher the rate lower the NPV thus above stated statement is true.