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 1 -$350 $40 $40 $40 $215 $215
Project 2 -$650 $200 $200 $70 $70 $70

Which project would you recommend?

Select the correct answer.

a. Project 1, since the NPV1 > NPV2.
b. Both Projects 1 and 2, since both projects have IRR's > 0.
c. Project 2, since the NPV2 > NPV1.
d. Both Projects 1 and 2, since both projects have NPV's > 0.
e. Neither Project 1 nor 2, since each project's NPV < 0.

Homework Answers

Answer #1

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

Project 1:

Present value of inflows=40/1.1+40/1.1^2+40/1.1^3+215/1.1^4+215/1.1^5

=$379.82

NPV=Present value of inflows-Present value of outflows

=(379.82-350)

=$29.82

Project 2:

Present value of inflows=200/1.1+200/1.1^2+70/1.1^3+70/1.1^4+70/1.1^5

=$490.97

NPV =$490.97-$650

=($159.03)(Negative)

Hence Project 1 must be selected having positive and higher NPV.

Hence the correct option is A.

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