Question

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

   Year 0 Year 1    Year 2    Year 3    Year 4    Year 5

Project 1	-$400	$40	$40	$40	$240	$240
Project 2	-$550	$200	$200	$105	$105	$105

Which project would you recommend?

Select the correct answer.

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

b. Project 1, since the NPV1 > NPV2.

c. Project 2, since the NPV2 > NPV1.

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

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

Answer 1

Answer: Option C is correct.

Using the cash flows given in the question, we calculated the NPV for both the projects.
The discount rate we used while calculating NPV is the WACC=10%

NPV of project 1=$12.42
NPV of project 2=$12.91
Both the projects are mutually exclusive, it means that only one project can be accepted. The project with higher NPV should be accepted.
So, project 2 should be accepted.