Question

A firm must choose between two mutually exclusive projects, A & B. Project A has an initial cost of $10000. Its projected net cash flows are $800, $2000, $3000, $4000, and $5000 at the end of years 1 through 5, respectively. Project B has an initial cost of $14000, and its projected net cash flows are $7000, $5000, $3000, $2000, and $1000 at the end of years 1 through 5, respectively. The firm’s cost of capital is 6.00%. Choose the correct statement:

		Project B should be chosen because it has the higher IRR
		Project B should be chosen because it has the higher NPV
		Project A should be chosen because it has the higher IRR
		Project A should be chosen because it has the higher NPV
		Both projects should be chosen because both have a positive NPV

Answer 1

NPV = Present Value of cash Inflows - Present Value of cash Outflows

NPV of Project A = [800*1/(1.06)^1+2000*1/(1.06)^2+3000*1/(1.06)^3+4000*1/(1.06)^4+5000*1/(1.06)^5]-10000

= $ 1,958.23

NPV of Project B = [7000*1/(1.06)^1+5000*1/(1.06)^2+3000*1/(1.06)^3+2000*1/(1.06)^4+1000*1/(1.06)^5]-14000

= $ 1,904.06

When a decision has to be made between two mutually exclusive projects, only one project can be chosen and the the project with the higher NPV is chosen.

Hence, Project A would be chosen

Answer = Project A should be chosen because it has the higher NPV