Question

Project S costs $19,000 and it's expected cash flows would be $6500 per year for 5 years. Mutually exclusive Project L costs $42,500 and it's expected cash flows would be $13,200 per year for 5 years. If both projects have a WACC of 15%, which project would you recommend?

a. Project L, since NPVL > NPVs

b. Both projects S and L, since both projects have IRR's > 0.

c. Both projects S and L, since both projects have NPVs > 0.

d. Project S, since the NPVs > NPVL

e. Neither project S nor L, since each project NPV < 0.

Answer 1

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

S:

Present value of inflows=6500/1.15+6500/1.15^2+..............+6500/1.15^5

=6500[1/1.15+1/1.15^2+.........+1/1.15^5]

=6500*3.352155098

=$21789.01

NPV=Present value of inflows-Present value of outflows

=(21789.01-19000)

=$2789.01(Approx)

L:

Present value of inflows=13200/1.15+13200/1.15^2+..........+13200/1.15^5

=13200[1/1.15+1/1.15^2+...............+1/1.15^5]

=$13200*3.352155098

=$44248.45

NPV =$44248.45-$42500

=$1748.45(Approx).

Since projects are mutually exclusive;hence S must be chosen only as NPV is S is greater than L.

Hence the correct option is D.