Question

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.

Answer 1

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.