Question

A firm with a WACC of 10% is considering the following mutually exclusive projects: 0 1 2 3 4 5 Project 1 -$450 $40 $40 $40 $175 $175 Project 2 -$650 $350 $350 $40 $40 $40 Which project would you recommend? Select the correct answer. a. Both Projects 1 and 2, since both projects have NPV's > 0. b. Project 2, since the NPV2 > NPV1. c. Both Projects 1 and 2, since both projects have IRR's > 0. d. Project 1, since the NPV1 > NPV2.

Answer 1

1:

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

=40/1.1+40/1.1^2+40/1.1^3+175/1.1^4+175/1.1^5

=$327.66

NPV=Present value of inflows-Present value of outflows

=$327.66-$450

=($122.34)(Approx)(Negative).

2:

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

=350/1.1+350/1.1^2+40/1.1^3+40/1.1^4+40/1.1^5

=$689.65

NPV=Present value of inflows-Present value of outflows

=$689.65-$650

=$39.65(Approx).

Hence project 2 must be selected having higher and positive NPV.(Option B)