Question

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

0 1 2 3 4 5

Project 1	-$450	$40	$40	$40	$190	$190
Project 2	-$500	$250	$250	$150	$150	$150

Which project would you recommend?

Select the correct answer.

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

b. Project 2, since the NPV2 > NPV1.

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

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

e. Project 1, since the NPV1 > NPV2.

Answer 1

1:

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

=40/1.1+40/1.1^2+40/1.1^3+190/1.1^4+190/1.1^5

=347.22

NPV=Present value of inflows-Present value of outflows

=347.22-450

=-102.78(Approx)(Negative)

2:

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

=250/1.1+250/1.1^2+150/1.1^3+150/1.1^4+150/1.1^5

=742.17

NPV=Present value of inflows-Present value of outflows

=742.17-500

=$242.17(Approx)

Hence project 2 must be selected having higher and positive NPV.

Hence the correct option is:

Project 2, since the NPV₂ > NPV₁.