Question

If there is no capital rationing problem, which of the following mutually exclusive projects should be accepted?

Project A: NPV = $8,000; NINV = $55,000

Project B: NPV = $11,000; NINV = $110,500

Question options:

Neither A nor B

A

B

Both A and B

D&D, Inc., plans to build a new toll way. The cost (NINV) of the project is expected to be $2.1 billion. Net cash inflows are expected to equal $351 million per year. How many years must the firm generate this cash inflow stream for investors to earn their required 16 percent rate of return?

Question options:

Around 19 years

Around 21 years

Around 9 years

Around 15 years

Answer 1

We can calculate the desired result as follows:

A) Project A: NPV = $8,000; Investment = $55,000

We need to calculate the profitability index of the projects to know which one will lead to greater returns

Profitability Index = NPV / Investment

= 8000 / 55000

= 0.1455 or 14.55%

Project B: NPV = $11,000; Investment = $110,500

Profitability Index = NPV / Investment

= 11000 / 110500

= 0.0995 or 9.95%

As the profitability index of Project A is greater that is 14.55% as compared to Project B which has only 9.95%, so project A should be accepted.

B) Net Investment (pv) = $ 2,100,000,000

Cash Inflows per year (pmt) = $ 351,000,000

Rate of Return (rate) = 16%

Number of years that the firm must generate the cash inflows to earn 16% rate can be calculated in the excel sheet calculator using the below formula:

=NPER(rate,pmt,-pv,fv)

=NPER(16%,351000000,-2100000000,0)

= 21.24 years.

So, the company must generate the cash flows for around 21 years to earn 16% rate of return.

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