Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.

Time | 0 | 1 | 2 | 3 |

Project A Cashflow | -20,000 | 10,000 | 30,000 | 1,000 |

Project B Cashflow | -30,000 | 10,000 | 20,000 | 50,000 |

Calculate the NPV and use the NPV decision rule to evaluate these projects; which one(s) should be accepted or rejected and why?

Answer #1

NPV = present value of cash inflows - present value of cash outflows

Project A:

Present value of cash inflow = 10,000 / ( 1 + 0.08)^{1}
+ 30,000 / ( 1 + 0.08)^{2} + 1,000 / ( 1 +
0.08)^{3}

Present value of cash inflow = 9,259.26 + 25,720.16 + 793.32

Present value of cash inflow = 35,772.74

NPV of project A = 35,772.74 - 20,000 = 15,772.74

Project B:

Present value of cash inflow = 10,000 / ( 1 + 0.08)^{1}
+ 20,000 / ( 1 + 0.08)^{2} + 50,000 / ( 1 +
0.08)^{3}

Present value of cash inflow = 9,259.26 + 17,146.78 + 39,691.61

Present value of cash inflow = 66,097.65

NPV of project B = 66,097.65 - 30,000 = 36,097.65

Since project B has higher NPV, project B should be accepted and project A should be rejected.

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Time
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