Question

Project S requires an initial outlay at t = 0 of $10,000, and its expected cash flows would be $6,500 per year for 5 years. Mutually exclusive Project L requires an initial outlay at t = 0 of $50,000, and its expected cash flows would be $13,750 per year for 5 years. If both projects have a WACC of 16%, which project would you recommend? Select the correct answer. a. Project L, since the NPVL > NPVS. b. Project S, since the NPVS > NPVL. c. Neither Project S nor L, since each project's NPV < 0. d. Both Projects S and L, since both projects have NPV's > 0. e. Both Projects S and L, since both projects have IRR's > 0.

Answer 1

S:

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

=6500/1.16+6500/1.16^2+6500/1.16^3+6500/1.16^4+6500/1.16^5

=21282.91

NPV=Present value of inflows-Present value of outflows

=21282.91-10,000

=$11282.91(Approx)

L:

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

=13750/1.16+13750/1.16^2+13750/1.16^3+13750/1.16^4+13750/1.16^5

=45021.54

NPV=Present value of inflows-Present value of outflows

=45021.54-50,000

=-4978.46(Approx)(Negative)

Hence S must be chosen having positive and higher NPV.

Hence the correct option is:

b. Project S, since the NPVS > NPVL.