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?

 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.

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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