Question

Project S costs $11,000 and its expected cash flows would be $7,000 per year for 5 years. Mutually exclusive Project L costs $38,000 and its expected cash flows would be $13,300 per year for 5 years. If both projects have a WACC of 12%, which project would you recommend?

Select the correct answer.

a. Project L, since the NPVL > NPVS.

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

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

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

e. Project S, since the NPVS > NPVL.

Answer 1

S:

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

=7000[1-(1.12)^-5]/0.12

=7000*3.604776202

=$25233.43

NPV=Present value of inflows-Present value of outflows

=$25233.43-$11000

=$14233.43(Approx).

L:

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

=13300[1-(1.12)^-5]/0.12

=13300*3.604776202

=$47943.52

NPV=Present value of inflows-Present value of outflows

=$47943.52-$38000

=$9943.52(Approx).

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