Question

You are considering two independent projects. The required rate of return is 13.75 percent for Project A and 14.25 percent for Project B. Project A has an initial cost of $51,400 and cash inflows of $21,400, $24,900, and $22,200 for Years 1 to 3, respectively. Project B has an initial cost of $38,300 and cash inflows of $23,000 a year for 2 years. Which project(s), if either, should you accept?

1. Accept both A and B
2. Reject both A and B
3. Accept A and reject B
4. Accept B and reject A
5. Accept either A or B but not both A and B

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= -$51,400. 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 13.75%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 13.75% required rate of return is $1,740.62.

Project B

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

• Press the CF button.
• CF0= -$38,300. 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 14.25%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 14.25% required rate of return is -$548.32.

Since project A has a positive net present value, it should be accepted. Project B should be rejected since it has a negative net present value.

Hence, the answer is option c.

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