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A firm is evaluating two projects for this year’s capital budget. Its WACC is 14%. Project...

A firm is evaluating two projects for this year’s capital budget. Its WACC is 14%. Project A costs $5,500 and its expected cash inflows would be $2,000 per year for 5 years. Project B costs $18,800 and its expected cash inflows would be $5,600 per year for 5 years. If the projects were mutually exclusive, which one would you recommend? If the projects were independent, which one(s) would you recommend? Explain.

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Answer #1

A:

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=$2000[1-(1.14)^-5]/0.14

=$2000*3.433080969

=$6866.16

NPV=Present value of inflows-Present value of outflows

=$6866.16-$5500

=$1366.16(Approx)

B:

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=$5600[1-(1.14)^-5]/0.14

=$5600*3.433080969

=$19225.25

NPV=Present value of inflows-Present value of outflows

=$19225.25-$18800

=$425.25(Approx).

a.Hence if projects are mutually exclusive;A must be accepted and B rejected having higher NPV.

b.Hence if projects are independent;both must be accepted having positive NPV.

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