Question

A company has the following mutually exclusive investment alternatives. The cash flows are shown below. Year Project A Project B 0 -$1,000 -$1,000 1 600 300 2 600 600 3 600 900 If the cost of capital is 10%, which investment(s) should the company select? Both Project A and Project B Project B with a NPV of $444.78 Project B with a NPV of $276.31 Project A with a NPV of $493.11 Project A with a NPV of $253.64

Answer 1

Answer: Project A with NPV of $ 493.11

	Computation of NPV
	Project A					Project B
	Year	Cashflows	PVF at 10%	PV		Year	Cashflows	PVF at 10%	PV
A	0	$          (1,000)	1.0000	$          (1,000)		0	$     (1,000)	1.0000	$             (1,000)
		PV of Cash Outflows		$          (1,000)			PV of Cash Outflows		$             (1,000)
B	1	$                600	0.9091	$          545.45		1	300	0.9091	$             272.73
	2	$                600	0.8264	$          495.87		2	600	0.8264	$             495.87
	3	$                600	0.7513	$          450.79		3	900	0.7513	$             676.18
		PV of Cash Inflows		$       1,493.11			PV of Cash Inflows		$         1,444.78
C	NPV	= B-A		$          493.11		NPV	= B-A		$             444.78

Given that the investment oppurtumities are mutually exclusive, Mutually-exclusive projects refer to a set of projects out of which only one project can be selected for investment. A decision to undertake one project from mutually exclusive projects excludes all other projects from consideration.

Though NPV is positive for both the investments, ony one can be selected, so, investment having higher NPV should be selected.

So, Project A with NPV od $ 493.11 should b selected.