Question

# Project S costs \$14,000 and its expected cash flows would be \$6,500 per year for 5...

Project S costs \$14,000 and its expected cash flows would be \$6,500 per year for 5 years. Mutually exclusive Project L costs \$37,500 and its expected cash flows would be \$14,700 per year for 5 years. If both projects have a WACC of 13%, which project would you recommend?

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

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

= Future value / (1 + r)n

The NPV of Project S is computed as follows:

= - \$ 14,000 + \$ 6,500 / 1.131 + \$ 6,500 / 1.132 + \$ 6,500 / 1.133 + \$ 6,500 / 1.134 + \$ 6,500 / 1.135

= \$ 8,862 Approximately

The NPV of Project L is computed as follows:

= - \$ 37,500 + \$ 14,700 / 1.131 + \$ 14,700 / 1.132 + \$ 14,700 / 1.133 + \$ 14,700 / 1.134 + \$ 14,700 / 1.135

= \$ 14,203 Approximately

Since these two projects are mutually exclusive, hence we need to select the one which has the higher NPV. Since the NPV of project L is greater than the NPV of project S, hence Project L shall be accepted.

So, the correct answer is option a.

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