Question

# Capital budgeting criteria: mutually exclusive projects. Project S costs \$17,000 and its expected cash flow would...

Capital budgeting criteria: mutually exclusive projects. Project S costs \$17,000 and its expected cash flow would be \$5,000 per year 5 years. Mutually exclusive Project L costs \$30,000 and its expected cash flow would be \$8,750 per year for 5 years. If both projects have a WACC of 12%, which project would you recommend? Explain.

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Project S:

Cost = \$17,000
Expected Cash Flows = \$5,000
Life of Project = 5 years
WACC = 12%

NPV = -\$17,000 + \$5,000/1.12 + \$5,000/1.12^2 + \$5,000/1.12^3 + \$5,000/1.12^4 + \$5,000/1.12^5
NPV = -\$17,000 + \$5,000 * (1 - (1/1.12)^5) / 0.12
NPV = -\$17,000 + \$5,000 * 3.60478
NPV = \$1,023.90

Project L:

Cost = \$30,000
Expected Cash Flows = \$8,750
Life of Project = 5 years
WACC = 12%

NPV = -\$30,000 + \$8,750/1.12 + \$8,750/1.12^2 + \$8,750/1.12^3 + \$8,750/1.12^4 + \$8,750/1.12^5
NPV = -\$30,000 + \$8,750 * (1 - (1/1.12)^5) / 0.12
NPV = -\$30,000 + \$8,750 * 3.60478
NPV = \$1,541.83

NPV of Project L is higher than that of Project S. So, we should choose Project L.