Which one of the following will decrease the net present value (NPV) of a project?

• A. An increase in the discount rate
• B. A decrease in the project's risk level
• C. A decrease in initial investment costs
• D. An increase in expected future cash flows

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the definition of Net Present Value (NPV). NPV is the sum of the present values of all cash inflows and outflows associated with a project, calculated as \(NPV = \sum_{t=0}^{T} \frac{C_t}{(1+r)^t}\), where \(C_t\) is the cash flow at time \(t\), \(r\) is the discount rate, and \(T\) is the project's time horizon.
2. Step 2: Recognize how the discount rate affects NPV. Since future cash flows are divided by \((1+r)^t\), an increase in the discount rate \(r\) increases the denominator, thus reducing the present value of future cash flows and lowering the NPV.
3. Step 3: Analyze the effect of a decrease in the project's risk level. Lower risk typically leads to a lower discount rate, which increases the present value of future cash flows and thus increases NPV.
4. Step 4: Consider the impact of a decrease in initial investment costs. Lower initial costs mean a smaller cash outflow at time zero, which directly increases NPV because the initial investment is subtracted from the sum of discounted inflows.
5. Step 5: Evaluate the effect of an increase in expected future cash flows. Higher future cash inflows increase the numerator \(C_t\) in the NPV formula, raising the present value of those cash flows and increasing the NPV.