Question

Carlyle Inc. is considering two mutually exclusive projects. Both require an initial investment of $15,000 at t = 0. Project S has an expected life of 2 years with after-tax cash inflows of $7,000 and $12,000 at the end of Years 1 and 2, respectively. Project L has an expected life of 4 years with after-tax cash inflows of $5,200 at the end of each of the next 4 years. Each project has a WACC of 9.00%, and neither can be repeated. The controller prefers Project S, but the CFO prefers Project L. How much value will the firm gain or lose if Project L is selected over Project S, i.e., what is the value of NPVL - NPVS?

$324.37 |
||

$262.74 |
||

$291.93 |
||

$392.48 |
||

$356.80 |

Answer #1

NPV = PV of Cash Inflows - PV of Cash Outflows

Project S:

Year |
CF |
PVF @9% |
Disc CF |

0 | $ -15,000.00 | 1.0000 | $ -15,000.00 |

1 | $ 7,000.00 | 0.9174 | $ 6,422.02 |

2 | $ 12,000.00 | 0.8417 | $ 10,100.16 |

NPV |
$ 1,522.18 |

Project L:

Year |
CF |
PVF @9% |
Disc CF |

0 | $ -15,000.00 | 1.0000 | $ -15,000.00 |

1 | $ 5,200.00 | 0.9174 | $ 4,770.64 |

2 | $ 5,200.00 | 0.8417 | $ 4,376.74 |

3 | $ 5,200.00 | 0.7722 | $ 4,015.35 |

4 | $ 5,200.00 | 0.7084 | $ 3,683.81 |

NPV |
$ 1,846.55 |

NPVL - NPVS

= $ 1846.55 - $ 1522.18

= $ 324.37

Option A is correct

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