Question

​(Mutually exclusive projects and NPV​) You have been assigned the task of evaluating two mutually exclusive projects with the following projected cash​ flows: If the appropriate discount rate on these projects is 11 ​percent, which would be chosen and​ why? What is the NPV of project​ A? ​$ nothing ​ (Round to the nearest​ cent.) What is the NPV of project​ B? ​$ ​(Round to the nearest​ cent.) Which project would be chosen and​ why? ​(Select the best choice​.) A. Choose Upper A because its NPV is higher. B. Cannot choose without comparing their IRRs. C. Choose both because they both have positive NPVs. D. Choose Upper B because its NPV is higher.

YEAR   PROJECT A CASH FLOW   PROJECT B CASH FLOW
0   -90,000   -90,000
1   30,000   0
2   30,000   0
3   30,000   0
4   30,000   0
5   30,000   200,000

Answer 1

NPV is the excess of present value of all cash inflows over present value of cash outflows.

Present value of cash outflows for both the projects = 90,000

Discount rate = 11%

Time	PVF(11%,n)	Project A Cash inflows	Project B Cash inflows	PV of cash inflows for Project A (Cashflow * PVF)	PV of cash inflows for Project B (Cashflow * PVF)
1	0.901	30,000	0	27030	0
2	0.812	30,000	0	24360	0
3	0.731	30,000	0	21930	0
4	0.659	30,000	0	19770	0
5	0.593	30,000	2,00,000	17790	118600
Total				110880	118600

NPV for project A = present value of all cash inflows - present value of cash outflows

= 110,880 - 90,000

= 20,880

NPV for project B = present value of all cash inflows - present value of cash outflows

= 118600 - 90,000

= 28,600

Project B should be chosen as the NPV of project B is higher than that of A.

In case of Mutually exclusive projects, If the NPV of one project is greater than the NPV of the other project, accept the project with the higher NPV, hence project B should be accepted.

Correct answer is D.

Choose Upper B because its NPV is higher.