Question

CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS Project S costs \$15,000 and its expected cash flows would...

CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS

Project S costs \$15,000 and its expected cash flows would be \$6,500 per year for 5 years. Mutually exclusive Project L costs \$45,000 and its expected cash flows would be \$9,900 per year for 5 years. If both projects have a WACC of 16%, which project would you recommend?

 a. Project S, since the NPVS > NPVL.
 b. Both Projects S and L, since both projects have NPV's > 0.
 c. Project L, since the NPVL > NPVS.
 d. Neither Project S nor L, since each project's NPV < 0.
 e. Both Projects S and L, since both projects have IRR's > 0.

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

S:

Present value of annuity=\$6500[1-(1.16)^-5]/0.16

=\$6500*3.274293654

=\$21282.91

NPV=Present value of inflows-Present value of outflows

=\$21282.91-\$15000

=\$6282.91

L:

Present value of annuity=\$9900[1-(1.16)^-5]/0.16

=\$9900*3.274293654

=\$32415.51

NPV=Present value of inflows-Present value of outflows

=\$32415.51-\$45000

=(12584.49)(Negative).

Hence S must be chosen having posiitve and higher NPV.

Hence the correct option is A.

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