Question

Two mutually exclusive projects have an initial cost of $12,000. Project A produces cash inflows of $10,200, $8,700, and $3,500 for years 1 through 3 respectively. Project B produces cash inflows of $6,700, $3,500, and $12,600 for years 1 through 3 respectively. The required rate is 10 percent. which project would you choose to invest in and why?

Answer 1

When projects are mutually exclusive, we should choose the project which has the highest NPV

Project A:

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

NPV = -12,000 + 10,200 / (1 + 0.1)^1 + 8,700 / (1 + 0.1)^2 + 3,500 / (1 + 0.1)^3

NPV = -12,000 + 9,272.7273 + 7,190.0826 + 2,629.6018

NPV = $7,092.41

Project B:

NPV = -12,000 + 6,700 / (1 + 0.1)^1 + 3,500 / (1 + 0.1)^2 + 12,600 / (1 + 0.1)^3

NPV = -12,000 + 6,090.9091 + 2,892.56198 + 9,466.56649

NPV = 6,450.04

Project A should be accepted as it has the highest NPV