Question

A company has the following mutually exclusive investment alternatives:

Year          Project A         Project B

0                -$1,000            -$1,000

1                      800                1,300

2                      800                   600

3                      800                   500

If the cost of capital is 10%, which investment(s) should the company select?

		Project A with a NPV of $989.48
		Project B with a NPV of $989.48
		Both project A and project B
		Project B with a NPV of $1,053.34
		Project A with a NPV of $1,075.96

Answer 1

A:

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

=800/1.1+800/1.1^2+800/1.1^3

=1989.48

NPV=Present value of inflows-Present value of outflows

=1989.48-1000

=$989.48(Approx)

B:

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

=1300/1.1+600/1.1^2+500/1.1^3

=2053.34

NPV=Present value of inflows-Present value of outflows

=2053.34-1000

=$1053.34(Approx)

When projects are mutually exclusive;project having higher NPV must be selected as it would lead to higher value addition to the company.

Hence project B must be selected having higher NPV

Hence the correct option is:

Project B with a NPV of $1,053.34