Question

Project S costs $13,000 and its expected cash flows would be $7,000 per year for 5 years. Mutually exclusive Project L costs $41,500 and its expected cash flows would be $10,500 per year for 5 years. If both projects have a WACC of 14%, which project would you recommend?

Select the correct answer.

a. Both Projects S and L, since both projects have IRR's > 0.

b. Project S, since the NPVS > NPVL.

c. Both Projects S and L, since both projects have NPV's > 0.

d. Neither Project S nor L, since each project's NPV < 0.

e. Project L, since the NPVL > NPVS.

Answer 1

S:

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=7000[1-(1.14)^-5]/0.14

=7000*3.433080969

=$24031.57

NPV=Present value of inflows-Present value of outflows

=$24031.57-$13000

=$11031.57(Approx).

L:

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=10500[1-(1.14)^-5]/0.14

=10500*3.433080969

=$36047.35

NPV=Present value of inflows-Present value of outflows

=$36047.35-$41500

=$(5452.65)(Approx).(Negative).

Hence S must be selected having higher NPV(Option B).