Question

# CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS A firm with a WACC of 10% is considering the...

CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS

A firm with a WACC of 10% is considering the following mutually exclusive projects:

 0 1 2 3 4 5
 Project 1 -\$250 \$75 \$75 \$75 \$170 \$170 Project 2 -\$700 \$200 \$200 \$50 \$50 \$50

Which project would you recommend?

 a. Neither Project 1 nor 2, since each project's NPV < 0.
 b. Both Projects 1 and 2, since both projects have NPV's > 0.
 c. Project 1, since the NPV1 > NPV2.
 d. Project 2, since the NPV2 > NPV1.
 e. Both Projects 1 and 2, since both projects have IRR's > 0.

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

Project 1:

Present value of inflows=75/1.1+75/1.1^2+75/1.1^3+170/1.1^4+170/1.1^5

=\$408.18

NPV=Present value of inflows-Present value of outflows

=408.18-250

=\$158.18

Project 2:

Present value of inflows=200/1.1+200/1.1^2+50/1.1^3+50/1.1^4+50/1.1^5

=\$449.87

NPV =\$449.87-\$700

=(\$250.13)(Approx)(Negative).

Hence Project 1 must be selected having higher and positive NPV.(C).

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