Question

Consider two projects with the following cash flows: Project S is a 4 year project with initial (time 0) cash outflow of 3000 and time 1 through 4 cash inflows of 1500, 1200, 800 and 300 respectively. Project L is a 4 year project with initial (time 0) cash outflow of 3000 and time 1 through 4 cash inflows of 400, 900, 1300, and 1500 respectively. Assuming a 5% cost of capital, determine which project should be chosen if the projects are independent.

Answer #1

Project should be chosen on the basis of NPV

NPV of project S = Present value of cash inflows - present value of cash outflows

NPV of project S = -3000 + 1500 / (1 + 0.05)^{1} + 1200
/ (1 + 0.05)^{2} + 800 / (1 + 0.05)^{3} + 300 / (1
+ 0.05)^{4}

NPV of project S = $454.89

NPV of project L = Present value of cash inflows - present value of cash outflows

NPV of project L = -3000 + 400 / (1 + 0.05)^{1} + 900 /
(1 + 0.05)^{2} + 1300 / (1 + 0.05)^{3} + 1500 / (1
+ 0.05)^{4}

NPV of project L = $554.32

Both projects should be accepted as bot projects have positive NPV

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