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 A -\$500 \$45 \$45 \$45 \$220 \$220 Project B -\$600 \$300 \$300 \$50 \$50 \$50 Which project would you recommend? Select the correct answer. I. Neither A or B, since each project's NPV < 0. II. Both Projects A and B, since both projects have NPV's > 0. III. Both Projects A and B, since both projects have IRR's > 0. IV. Project B, since the NPVB > NPVA. V. Project A, since the NPVA > NPVB.

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

A:

Present value of inflows=45/1.1+45/1.1^2+45/1.1^3+220/1.1^4+220/1.1^5

=\$398.77

NPV=Present value of inflows-Present value of outflows

=\$398.77-\$500

=(\$101.23)(Approx)(Negative)

B:

Present value of inflows=300/1.1+300/1.1^2+50/1.1^3+50/1.1^4+50/1.1^5

=\$623.42

NPV=Present value of inflows-Present value of outflows

=\$623.42-\$600

=\$23.42(Approx)

Hence since project B has positive NPV ;B must be selected while A rejected.

Hence the correct option is IV.

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