Question

Ace Inc. is evaluating two mutually exclusive projects—Project A and Project B. The initial cash outflow is $50,000 for each project. Project A results in cash inflows of $15,625 at the end of each of the next five years. Project B results in one cash inflow of $99,500 at the end of the fifth year. The required rate of return of Ace Inc. is 10 percent. Ace Inc. should invest in:

a. ​Project B because it has no cash inflows in the first four years of its life.

b. ​Project A because it has a positive net present value (NPV).

c. ​Project B because it has a higher net present value (NPV).

d. ​Project A because it will generate cash in the initial years of its life.

e. ​Project A because it will yield cash every year for five years.

Answer 1

Net Present Value =  Present Value of Cash Inflows -Present Value of Cash Outflows

Project A:

Net Present Value =[15625*1/(1.10)^1+15625*1/(1.10)^2+15625*1/(1.10)^3+15625*1/(1.10)^4+15625*1/(1.10)^5]-50,000

= $ 9231.04

Project B:

Net Present Value= [99500*1/(1.10)^5]-50,000

= $ 11,781.67

Since the projects are mutually exclusive, only one project could be chosen. The project with the higher Net Present value would be selected as it would be more beneficial .

Since Project B has a higher Net Present value, it would be chosen

Answer : c. ​Project B because it has a higher net present value (NPV).