Question

1.      Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.

Time	0	1	2	3
Project A Cash Flow	?1,000	300	400	700
Project B Cash Flow	?500	200	400	300

Use the NPV decision rule to evaluate these projects; which one(s) should be accepted or rejected?

A.      ACCEPT BOTH A AND B

B.       ACCEPT NEITHER A NOR B

C.       ACCEPT A, REJECT B

D.      REJECT A, ACCEPT B

Answer 1

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

A:

Present value of inflows=300/1.1+400/1.1^2+700/1.1^3

=$1129.23

NPV=Present value of inflows-Present value of outflows

=$1129.23-$1000

=$129.23(Approx)

B:

Present value of inflows=200/1.1+400/1.1^2+300/1.1^3

=$737.79

NPV=Present value of inflows-Present value of outflows

=$737.79-$500

=$237.79(Approx)

Hence since projects are mutually exlcusive;project having highest NPV must be chosen.Hence project B must be accepted and A rejected.(D)