Question

In: Finance

Use the following for Questions 1 - 4: You are considering two mutually exclusive projects, A...

Use the following for Questions 1 - 4:

You are considering two mutually exclusive projects, A and B.

Project A costs $70,000 and generates cash flows of $12,000 for 10 years.

Project B costs $60,000 and generates cash flows of $2,000 for six years and then cash flows of $29,000 for four years.

Report rates in percentage form to two decimal places i.e. 10.03% not 10%

Question 1

At what discount rate would make you indifferent between choosing one project or another?

Question 2

Which project would you ACCEPT if your discount rate was 10%?

A) Project A

B) Project B

C) Both Project A and B

D) Neither Project A or B

Question 3

Which project would you ACCEPT if your discount rate was 5%?

A) Project A

B) Project B

C) Both Project A and B

D) Neither Project A or B

Question 4

What is the highest discount rate in which you can still produce a non-negative NPV?

Solutions

Expert Solution

1-

Year

Project B

Project A

incremental cash flow = cash flow A- cash flow B

2-

Year

Project B

Project A

0

-60000

-70000

-10000

0

-60000

-70000

1

2000

12000

10000

1

2000

12000

2

2000

12000

10000

2

2000

12000

3

2000

12000

10000

3

2000

12000

4

2000

12000

10000

4

2000

12000

5

2000

12000

10000

5

2000

12000

6

2000

12000

10000

6

2000

12000

7

29000

12000

-17000

7

29000

12000

8

29000

12000

-17000

8

29000

12000

9

29000

12000

-17000

9

29000

12000

10

29000

12000

-17000

10

29000

12000

Cross over rate

Using IRR function in MS excel

7.47%

IRR = Using IRR function in MS excel

10.14%

11.23%

Both project A & B would be selected on the basis of IRR if discount rate is 10% but as projects are mutually exclusive then project with higher IRR would be selected and project A would be selected

3-

Both project A & B would be selected on the basis of IRR if discount rate is 5% but as projects are mutually exclusive then project with higher IRR would be selected and project A would be selected

4-

IRR is the discount at which NPV would be non negative


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