Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively.

Time:	0	1	2	3
Project A Cash Flow	-30,000	20,000	40,000	11,000
Project B Cash Flow	-40,000	20,000	30,000	60,000

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

a. reject A, accept B

b. accept neither A or B

c. accept A, reject B

d. accept both A and B

Answer 1

A:

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

=20,000/1.08+40,000/1.08^2+11000/1.08^3

=61544.23

NPV=Present value of inflows-Present value of outflows

=61544.23-30,000

=$31544.23(Approx)

B:

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

=20,000/1.08+30,000/1.08^2+60,000/1.08^3

=91868.62

NPV=Present value of inflows-Present value of outflows

=91868.62-40,000

=$51868.62(Approx)

Hence since projects are mutually exclusive;project B must be selected only having higher NPV.

Hence the correct option is:

a. reject A, accept B