Question

Suppose a company has two mutually exclusive projects, both of which are three years in length. Project A has an initial outlay of $6,000 and has expected cash flows of $4,000 in year 1, $5,000 in year 2, and $5,000 in year 3. Project B has an initial outlay of $9,000 and has expected cash flows of $2,000 in year 1, $4,000 in year 2, and $5,000 in year 3. The required rate of return is 10% for projects at this company. What is the net present value for the best project? (Answer to the nearest dollar.)

Answer 1

Project A

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

• Press the CF button.
• CF0= -$6,000. 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 required rate of return of 10%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 10% required rate of return is $5,525.17.

Project B

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

• Press the CF button.
• CF0= -$9,000. 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 required rate of return of 10%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 10% required rate of return is -$119.46.

The decision rule of net present value says to accept projects with a positive net present value and reject projects with a negative net present value.

The net present value of the best project is that of project A which is $5,525.17.

In case of any query, kindly comment on the solution.