Question

A firm with a WACC of 10% is considering the following mutually exclusive projects:

0

1

2

3

4

5

Project 1	-$300	$40	$40	$40	$165	$165
Project 2	-$400	$200	$200	$60	$60	$60

Which project would you recommend?

Select the correct answer.

a. Project 1, since the NPV1 > NPV2.

b. Neither Project 1 nor 2, since each project's NPV < 0.

c. Both Projects 1 and 2, since both projects have IRR's > 0.

d. Project 2, since the NPV2 > NPV1.

e. Both Projects 1 and 2, since both projects have NPV's > 0.

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+165/1.1^4+165/1.1^5

=$314.62

NPV=Present value of inflows-Present value of outflows

=$314.62-$300

=$14.62(Approx).

2:

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

=200/1.1+200/1.1^2+60/1.1^3+60/1.1^4+60/1.1^5

=$470.42

NPV=Present value of inflows-Present value of outflows

=$470.42-$400

=$70.42(Approx).

Hence project 2 must be selected having higher NPV.(Option D).