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 9 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	-21,000	11,000	31,000	2,000
Project B Cash Flow	-31,000	11,000	21,000	51,000

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

Multiple Choice

• accept both A and B

• accept A, reject B

• reject A, accept B

• accept neither A nor B

Answer 1

Project A:

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

NPV = -21,000 + 11,000 / (1 + 0.09)^1 + 31,000 / (1 + 0.09)^2 + 2,000 / (1 + 0.09)^3

NPV = -21,000 + 10,091.74312 + 26,092.07979 + 1,544.36696

NPV = $16,728.19

Project B:

NPV = -31,000 + 11,000 / (1 + 0.09)^1 + 21,000 / (1 + 0.09)^2 + 51,000 / (1 + 0.09)^3

NPV = -31,000 + 10,091.74312 + 17,675.27986 + 39,381.35748

NPV = $36,148.38

When projects are mutually exclusive, we can only select 1 project. We should choose the project with highest NPV.

reject A, accept B