Question

A company with a WACC of 10% is considering the following mutually exclusive projects:

Years 0 1 2 3 4 5

Project 1 -$300 $50 $50 $50 $180 $180

Project 2 -$400 $200 $200 $80 $80 $80

Which project would you recommend?

a. Project 2, since the NPV of Project 2 > NPV of Project 1

b. Neither Project 1 nor 2, since each project's NPV < 0

c. Project 1, since the NPV of Project 1 > the NPV of Project 2

d. Both Projects 1 and 2, since both projects have NPV's > 0

Answer 1

Answer is Option A

NPV is difference between PV of cash inflows and the PV of cash outflows over a period of time.

In order to answer the above question,we need to first calculate NPV for both the projects with WACC of 10%.

NPV (Project 1) = 59.05

NPV (Project 2) = 111.53

Clearly, Project 2's NPV > Project 1's NPV --> Hence answer is A. Higher the NPV, more value does a project add to firm. Also, remember this is a case of mutually exclusive project, which means only one of the two projects can be selected.