Question

Project S costs $18,000 and its expected cash flows would be $7,000 per year for 5 years. Mutually exclusive Project L costs $35,000 and its expected cash flows would be $8,400 per year for 5 years. If both projects have a WACC of 12%, which project would you recommend? Select the correct answer. a. Project S, since the NPVS > NPVL. b. Neither Project S nor L, since each project's NPV < 0. c. Both Projects S and L, since both projects have NPV's > 0. d. Both Projects S and L, since both projects have IRR's > 0. e. Project L, since the NPVL > NPVS.

Answer 1

When projects are mutually exclusive, we should choose the project with a higher NPV.

NPV of project S = Annuity * [1 - 1 / (1 + r)ⁿ] / r - initial investment

NPV of project S = 7000 * [1 - 1 / (1 + 0.12)⁵] / 0.12 - 18,000

NPV of project S = 7000 * 3.60478 - 18,000

NPV of project S = $7,233.43

NPV of project L = Annuity * [1 - 1 / (1 + r)ⁿ] / r - initial investment

NPV of project L = 8,400 * [1 - 1 / (1 + 0.12)⁵] / 0.12 - 35,000

NPV of project L = 8,400 * 3.60478 - 35,000

NPV of project L = -$4,719.85

Project S, since the NPVS > NPVL