Question

Capital budgeting criteria: mutually exclusive projects

Project S costs $11,000 and its expected cash flows would be $4,000 per year for 5 years. Mutually exclusive Project L costs $32,000 and its expected cash flows would be $14,700 per year for 5 years. If both projects have a WACC of 15%, which project would you recommend?

Select the correct answer.

I. Neither S or L, since each project's NPV < 0.

II. Project L, since the NPVL > NPVS.

III. Project S, since the NPVS > NPVL.

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

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

Answer 1

Sloution :-
i)	Evaluation of project "S"
	Present value of cash inflows	=Annual equal cash inflows *PVIFA (PIR,n)
		=$4000*PVIFA(15%,5)
		=$4000*3.352155
		=$13408.62
	Note:-	PIR=peridice interest rate
		n= no of years
	NPV of project "S"	=Present value of cash inflows - present value of outflows
		=$13408.62-$11000
		=$2408.62
ii)	Evaluation of project "L"
	Present value of cash inflows	=Annual equal cash inflows *PVIFA (PIR,n)
		=$14700*PVIFA(15%,5)
		=$14700*3.352155
		=$49276.68
	Note:-	PIR=peridice interest rate
		n= no of years
	NPV of project "L"	=Present value of cash inflows - present value of outflows
		=$49276.68-$32000
		=$17,276.68
	Since the projects are mutually exclusive hence project "L" should be selected since NPVL>NPVS, hence the correct choice would be "ii"