Question

Consider two projects with the following cash flows: Project S is a 4 year project with initial (time 0) cash outflow of 3000 and time 1 through 4 cash inflows of 1500, 1200, 800 and 300 respectively. Project L is a 4 year project with initial (time 0) cash outflow of 3000 and time 1 through 4 cash inflows of 400, 900, 1300, and 1500 respectively. Assuming a 5% cost of capital, determine which project should be chosen if the projects are independent.

Answer 1

Project S:

Cost of Capital = 5 %

Cash Flows:

Year 0 = - $ 3000

Year 1 = $ 1500

Year 2 = $ 1200

Year 3 = $ 800

Year 4 = $ 300

Project NPV = - 3000 + 1500 / (1.05) + 1200 / (1.05)^(2) + 800 / (1.05)^(3) + 300 / (1.05)^(4) = $ 454.89

Project L:

Cost of Capital = 5 %

Cash Flows:

Year 0 = - $ 3000

Year 1 = $ 400

Year 2 = $ 900

Year 3 = $ 1300

Year 4 = $ 1500

Project NPV = - 3000 + 400 / (1.05) + 900 / (1.05)^(2) + 1300 / (1.05)^(3) + 1500 / (1.05)^(4) = $ 554.32

As Project L has a greater NPV than Project S the former should be chosen.