Question

Project S costs $17,000 and its expected cash flows would be $4,000 per year for 5 years. Mutually exclusive Project L costs $25,000 and its expected cash flows would be $10,200 per year for 5 years. If both projects have a WACC of 12%, which project would you recommend? Select the correct answer.

a. Project L, since the NPVL > NPVS.

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

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

d. Project S, since the NPVS > NPVL.

e. Neither Project S nor L, since each project's NPV < 0.

Answer 1

Answer - Option (a) Project L, since the NPVL > NPVS.

Calculation of NPV as follows :-

NPV of Project S = Present Value of cash Inflow - Present Value of cash Outflow

Present Value of cash Inflow = (4000 / 1.12)1 + (4000 / 1.12)2+ (4000 / 1.12)3+ (4000 / 1.12)4+ (4000 / 1.12)5

Present Value of cash Inflow = $3571.4286 + $3188.7755 + $2847.12099 + $2542.0723 + $2269.7074

Present Value of cash Inflow = $14419.10481

Present Value of cash Outflow = $17000

NPV of Project S = $14419.10481 - $17000

NPV of Project S = (-) $2580.895

NPV of Project L = Present Value of cash Inflow - Present Value of cash Outflow

Present Value of cash Inflow = (10200 / 1.12)1 + (10200 / 1.12)2+ (10200 / 1.12)3+ (10200 / 1.12)4+ (10200 / 1.12)5

Present Value of cash Inflow = $9107.142857 + $8131.377551 + $7260.158528 + $6482.2844 + $5787.753928

Present Value of cash Inflow = $36768.71726

Present Value of cash Outflow = $25000

NPV of project L = $36768.71726 - $25000

NPV of project L = $11768.717