Question

Project S requires an initial outlay at t = 0 of $13,000, and its expected cash flows would be $5,000 per year for 5 years. Mutually exclusive Project L requires an initial outlay at t = 0 of $47,500, and its expected cash flows would be $13,800 per year for 5 years. If both projects have a WACC of 14%, which project would you recommend?

Select the correct answer.

a. Project L, since the NPVL > NPVS.

b. Project S, since the NPVS > NPVL.

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

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

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

Answer 1

Project S

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

• Press the CF button.
• CF0= -$13,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the weighted average cost of capital of 14%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 14% weighted average cost of capital is $4,165.40.

Project L

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

• Press the CF button.
• CF0= -$47,500. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the weighted average cost of capital of 14%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 14% weighted average cost of capital is -$123.48.

Therefore, I will recommend Project S since it has the highest net present value.

Hence, the answer is option b.