Question

11-11 CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS $225 $225 $50 $49 Project S costs $15,000, and its expected cash flows would be $4,500 per year for 5 years. Mutually exclusive Project L costs $37,500, and its expected cash flows would be $11,100 per year for 5 years. If both projects have a WACC of 14%, which project would you recommend? Explain

Answer 1

Present value of annuity=annuity[1-(1+rate)^-time period]/rate

1.Present value of inflows=4500[1-(1.14)^-5]/0.14

=4500*3.433080969

=$15448.86

NPV=Present value of inflows-Present value of outflows

=$15448.86-$15000

=$448.86

2.Present value of inflows=11100[1-(1.14)^-5]/0.14

=11100*3.433080969

=$38107.20

NPV=Present value of inflows-Present value of outflows

=$38107.20-$37500

=$607.20

Hence since projects are mutually exclusive;project having higher NPV must be preferred.

Hence project L must be selected.