Question

Which mutually exclusive project would you select, if both requires initial investment at $10,000 and your discount rate is 8%; Project A with seven annual cash flows of $5,000, or Project B, with four years of zero cash flow followed by lump sum of 35,000 in year five?

Answer 1

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 A is computed as follows:

= - $ 10,000 + $ 5,000 / 1.081 + $ 5,000 / 1.082 + $ 5,000 / 1.083 + $ 5,000 / 1.084 + $ 5,000 / 1.085 + $ 5,000 / 1.086 + $ 5,000 / 1.087

= $ 16,031.8503

The NPV of project B is computed as follows:

= - $ 10,000 + $ 35,000 / 1.085

= $ 13,820.4119

Since the NPV of Project A is greater than the NPV of Project B, hence Project A shall be selected.