Question

Capital budgeting criteria: mutually exclusive projects

Project S costs $17,000 and its expected cash flows would be $7,000 per year for 5 years. Mutually exclusive Project L costs $49,000 and its expected cash flows would be $15,000 per year for 5 years. If both projects have a WACC of 13%, which project would you recommend?

Select the correct answer.

I. Project L, since the NPVL > NPVS.

II. Neither S or L, since each project's NPV < 0.

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

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

V. Project S, since the NPVS > NPVL.

Answer 1

Both the projects have same duration.

Since these projects are mutually exclusive, we can select only one project.

NPV is better way of finding the worth of the project as it calculate the value that projects will deliver in terms of cash while IRR gives the rate at which NPV equals zero.

NPV of project S = $7620.62 Answer

NPV of project L = $ 3758,47 Answer

Since NPV of project S is higher than project L , you would recommend project S.

Option V is correct.

Because of above calculation other options will be ruled out.