Question

Consider the following two projects A and B. Assume that the appropriate discount rate for each project is 20%.

Year CF for Project A CF for Project B

0 -$100 - $1,700

1 70 900

2 80 900

3 90 900

If projects A and B are independent projects, which project(s) should you accept based on your best capital budgeting criteria? Please explain your rationale.

If projects A and B are mutually exclusive projects, which project(s) should you accept based on your best capital budgeting criteria? Please explain your rationale.

Answer 1

Project A

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• •   Press the CF button.
• •   CF0= -$100. It is entered with a negative sign since it is a cash outflow.
• •   Cash flow for all the years should be entered.
• •   Press Enter and down arrow after inputting each cash flow.
• •   After entering the last cash flow, press the NPV button and enter the discount rate of 20%.
• •   Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 20% discount rate is $65.97.

Project B

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• •   Press the CF button.
• •   CF0= -$1,700. It is entered with a negative sign since it is a cash outflow.
• •   Cash flow for all the years should be entered.
• •   Press Enter and down arrow after inputting each cash flow.
• •   After entering the last cash flow, press the NPV button and enter the discount rate of 20%.
• •   Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 20% discount rate is $195.83.

If the projects are independent, both the projects should be accepted according to the net present value decision rule since both projects have a positive net present value.

If the projects are mutually exclusive, Project B should be accepted according to the net present value decision rule since it has the highest net present value.

In case of any query, kindly comment on the solution.