Question

Project S costs $11,000 and its expected cash flows would be $6,000 per year for 5 years. Mutually exclusive Project L costs $30,500 and its expected cash flows would be $14,500 per year for 5 years. If both projects have a WACC of 16%, which project would you recommend?

Select the correct answer.

a. Both Projects S and L, since both projects have IRR's > 0.

b. Both Projects S and L, since both projects have NPV's > 0.

c. Project S, since the NPVS > NPVL.

d. Project L, since the NPVL > NPVS.

e. Neither Project S nor L, since each project's NPV < 0.

Answer 1

NPV & IRR
Project S
Year	Cash Flow	DF for 16%	Discounted Cash Flow	FOR IRR 40%	DF for 40%	Discounted Cash Flow
0	-11000	1	$                    (11,000.00)		1	$                           (11,000.00)
1	6000	0.8621	$                         5,172.41		0.71429	$                               4,285.71
2	6000	0.7432	$                         4,458.98		0.51020	$                               3,061.22
3	6000	0.6407	$                         3,843.95		0.36443	$                               2,186.59
4	6000	0.5523	$                         3,313.75		0.26031	$                               1,561.85
5	6000	0.4761	$                         2,856.68		0.18593	$                               1,115.61
		NPV	$                         8,645.76		NPV	$                               1,210.98
	IRR	=Ra + NPV @ Ra (Rb-Ra)				Ra = Lower discount rate
		NPV @ Ra - NPV @ Rb				Rb = higher discount rate
		=0.16 + [ ((8645.76 X (.40 - .16)) / (8645.76 - 1210.98)
		=0.16 + (1.162881 X (.40 - .16))
		0.44
		44%
Project L
Year	Cash Flow	DF for 16%	Discounted Cash Flow	FOR IRR 40%	DF for 40%	Discounted Cash Flow
0	-30500	1	$                    (30,500.00)		1	$                           (30,500.00)
1	14500	0.8621	$                       12,500.00		0.71429	$                             10,357.14
2	14500	0.7432	$                       10,775.86		0.51020	$                               7,397.96
3	14500	0.6407	$                         9,289.54		0.36443	$                               5,284.26
4	14500	0.5523	$                         8,008.22		0.26031	$                               3,774.47
5	14500	0.4761	$                         6,903.64		0.18593	$                               2,696.05
		NPV	$                       16,977.26		NPV	$                                 (990.12)
	IRR	=Ra + NPV @ Ra (Rb-Ra)				Ra = Lower discount rate
		NPV @ Ra - NPV @ Rb				Rb = higher discount rate
		=0.16 + [ ((16977.26 X (.40 - .16)) / (16977.26 - (-990.123))
		=0.16 + (0.944 X (.40 - .16))
		0.38
		38%
Based on NPV Project L is recommended
Based on IRR Project S is recommended
The Best way to select the project is NPV so project L is recommended