Question

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

0

1

2

3

4

5

Project 1	-$300	$45	$45	$45	$200	$200
Project 2	-$650	$250	$250	$45	$45	$45

Which project would you recommend?

Select the correct answer.

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

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

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

d. Project 2, since the NPV2 > NPV1.

e. Project 1, since the NPV1 > NPV2.

Answer 1

1:

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

=45/1.1+45/1.1^2+45/1.1^3+200/1.1^4+200/1.1^5

=$372.70

NPV=Present value of inflows-Present value of outflows

=$372.70-$300

=$72.70(Approx).

2:

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

=250/1.1+250/1.1^2+45/1.1^3+45/1.1^4+45/1.1^5

=$526.37

NPV=Present value of inflows-Present value of outflows

=$526.37-$650

=$(123.63)(Approx).

Hence Project 1 must be selected having higher NPV.(Option E).