Question

Project S requires an initial outlay at t = 0 of $11,000, and its expected cash flows would be $7,000 per year for 5 years. Mutually exclusive Project L requires an initial outlay at t = 0 of $26,000, and its expected cash flows would be $10,800 per year for 5 years. If both projects have a WACC of 14%, which project would you recommend? Select the correct answer. a. Neither Project S nor L, since each project's NPV < 0. b. Project L, since the NPVL > NPVS. c. Project S, since the NPVS > NPVL. d. Both Projects S and L, since both projects have NPV's > 0. e. Both Projects S and L, since both projects have IRR's > 0.

Answer 1

We can calculate the Present Value of both the projects given using the Excel sheet as below

The formulas used in excel sheet are

As initial cash outlay is required for both projects, so value in year 0 is in negative.

So, with the given WACC of 14% the NPV of both projects come out to be

NPV of Project S is $ 13,032

NPV of Project L is $ 11,077

Therefore as the NPV of both the projects is positive, so both look feasible. However Project S has higher NPV than Project L, so Project S should be selected over Project L.

Hence, the correct answer is option (c) Project S, since the NPVS > NPVL

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