Question

A firm must choose between two mutually exclusive projects, A & B. Project A has an initial cost of $11000. Its projected net cash flows are $900, $2000, $3000, $4000, and $5000 at the end of years 1 through 5, respectively. Project B has an initial cost of $15000, and its projected net cash flows are $7000, $5000, $3000, $2000, and $1000 at the end of years 1 through 5, respectively. If the firm’s cost of capital is 6.00%: 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

Mutually exclusive projects are those, out of which only one can be accepted

NPV is better decision creteria while evaluating mutually exclusive projects

NPV = Present value of cash inflows - Present value of cash outflows

= -11000 + 900/(1.06) + 2000/(1.06)^2 + 3000/(1.06)^3 + 4000/(1.06)^4 + 5000/(1.06)^5

=$1,052.57

Project B = -15000 + 7000/(1.06) + 5000/(1.06)^2 + 3000/(1.06)^3 + 2000/(1.06)^4 + 1000/(1.06)^5

= $904.06

Hence, the answer is

Project A should be chosen because it has the higher NPV