Question

You are considering two independent projects. The required rate of return is 13.75 percent for Project A and 14.25 percent for Project B. Project A has an initial cost of $51,400 and cash inflows of $21,400, $24,900, and $22,200 for Years 1 to 3, respectively. Project B has an initial cost of $38,300 and cash inflows of $18,000 a year for 3 years. Which project(s), if any, should you accept?

	A.	Reject both Projects.
	B.	Accept both projects.
	C.	Accept Project B and reject Project A.
	D.	Accept project A and reject Project B.

Answer 1

A:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=21400/1.1375+24900/1.1375^2+22200/1.1375^3

=$53140.62

NPV=Present value of inflows-Present value of outflows

=$53140.62-$51400

=$1740.62(Approx).

B:

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

=18000[1-(1.1425)^-3]/0.1425

=18000*2.311927582

=$41614.70

NPV=Present value of inflows-Present value of outflows

=$41614.70-$38300

=$3314.70(Approx).

Hence since both projects have positive NPV and are independent;both must be selected.(Option B).