Question

Project S costs $13,000 and its expected cash flows would be $5,000 per year for 5 years. Mutually exclusive Project L costs $34,500 and its expected cash flows would be $11,100 per year for 5 years. If both projects have a WACC of 15%, which project would you recommend? Select the correct answer. a. Project S, since the NPVS > NPVL. b. Both Projects S and L, since both projects have NPV's > 0. c. Both Projects S and L, since both projects have IRR's > 0. d. Project L, since the NPVL > NPVS. e. Neither Project S nor L, since each project's NPV < 0.

Answer 1

NPV = Present value of future cash inflows - present value of cash outflows

NPV of project S = -13000 + 5000 / ( 1 + 0.15)¹ + 5000 / ( 1 + 0.15)² + 5000 / ( 1 + 0.15)³ + 5000 / ( 1 + 0.15)⁴ + 5000 / ( 1 + 0.15)⁵

NPV of project S = $3,760.8

IRR of project S using a financial calculator = 26.6%

Keys to use in a finacial calculator: CF0 = -13,000, C1 = 5000, F1 = 5, CPT, IRR)

NPV of project L = -34,500 + 11,100 / ( 1 + 0.15)¹ + 11,100 / ( 1 + 0.15)² + 11,100 / ( 1 + 0.15)³ + 11,100 / ( 1 + 0.15)⁴ + 11,100 / ( 1 + 0.15)⁵

NPV of project L = $2,708.9

IRR of project L using a financial calculator = 18.27%

Keys to use in a finacial calculator: CF0 = -34500, C1 = 11100, F1 = 5, CPT, IRR)

Since these are mutually exclusive projects, we select project S, since NPVS > NPVL