Question

Problem 11-10 Capital Budgeting Criteria: Mutually Exclusive Projects. A firm with a WACC of 10% is considering the following mutually exclusive projects:

0 1 2 3 4 5

|--------------|-----------------|-----------------|-----------------|-------------------|

Project A -$200 $75 $75 $75 $190 $190

Project B -$650 $250 $250 $125 $125 $125

Which project would you recommend? Explain.

Answer 1

The net present value is used to make a decision in case of mutually exclusive projects.

Project A

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

• Press the CF button.
• CF0= -$200. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the weighted average cost of capital of 10%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 10% weighted average cost of capital is $234.26.

Project B

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

• Press the CF button.
• CF0= -$650. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the weighted average cost of capital of 10%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 10% weighted average cost of capital is $40.79.

I would recommend selecting Project A since it has a higher net present value.

In case of any query, kindly comment on the solution