Question

You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value.

Project A

Year	Cash Flow
0	-$75,000
1	$19,000
2	$48,000
3	$12,000

Project B

Year	Cash Flow
0	-$70,000
1	$10,000
2	$16,000
3	$72, 000

Required rate of return 10% 13%
Required payback period 2.0 years 2.0 years

Based on the net present value method of analysis and given the information in the problem, you should:

A. accept both project A and project B.

B. accept project A and reject project B.

C.  accept project B and reject project A.

D. reject both project A and project B.

E. accept whichever one you want as they represent equal opportunities.

Answer 1

The NPV of the project is computed as shown below:

= Initial investment + Present value of future cash flows

So, the NPV of project A is computed as follows:

= - $ 75,000 + $ 19,000 / 1.10 + $ 48,000 / 1.10² + $ 12,000 / 1.10³

= - $ 9,042.07 Approximately

The NPV of project B is computed as follows:

= - $ 70,000 + $ 10,000 / 1.13 + $ 16,000 / 1.13² + $ 72,000 / 1.13³

= $ 1,279.52 Approximately

Since the NPV of project A is negative. Hence only Project B shall be accepted.

So, the correct answer is option c.

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