Question

Project R requires an initial outlay at t = 0 of $14,000, and its expected cash flows would be $6,000 per year for 5 years. Mutually exclusive Project L requires an initial outlay at t = 0 of $32,500, and its expected cash flows would be $13,050 per year for 5 years. If both projects have a WACC of 14%, which project would you recommend?

Select the correct answer.

a. Neither Project S nor L, since each project's NPV < 0.

b. Project L, since the NPVL > NPVS.

c. Both Projects S and L, since both projects have NPV's > 0.

d. Project S, since the NPVS > NPVL.

e. Both Projects S and L, since both projects have IRR's > 0.

Answer 1

Project S:

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

NPV = Annuity * [1 - 1 / (1 + r)^n] / r - Initial investment

NPV = 6000 * [1 - 1 / (1 + 0.14)^5] / 0.14 - 14,000

NPV = 6000 * [1 - 0.519369] / 0.14 - 14,000

NPV = 6000 * 3.433081 - 14,000

NPV = $6,598.49

Project L:

NPV = Annuity * [1 - 1 / (1 + r)^n] / r - Initial investment

NPV = 13,050 * [1 - 1 / (1 + 0.14)^5] / 0.14 - 32,500

NPV = 13,050 * [1 - 0.519369] / 0.14 - 32,500

NPV = 13,050 * 3.433081 - 32,500

NPV = $12,301.71

b. project L, since the NPVL>NPVS