Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively.

Time: 0 1 2 3

Project A Cash Flow: -30,000 20,000 40,000 11,000

Project B Cash Flow: -40,000 20,000 30,000 60,000

Use the NPV decision rule to evaluate these projects; which one(s) should it be accepted or rejected?

Answer 1

A

Year	Cash flow	× discount rate	Present value
0	$        (30,000)	1.0000	$            (30,000.00)
1	$          20,000	0.9259	$             18,518.00
2	$          40,000	0.8573	$             34,292.00
3	$          11,000	0.7938	$                8,731.80
NPV			$             31,541.80

NPV is $31,541.80

B

Year	Cash flow	× discount rate	Present value
0	$        (40,000)	1.0000	$            (40,000.00)
1	$          20,000	0.9259	$             18,518.00
2	$          30,000	0.8573	$             25,719.00
3	$          60,000	0.7938	$             47,628.00
NPV			$             51,865.00

NPV of B is $51,865

Both are accepted.