Question

A firm with a WACC of 10% is considering the following mutually exclusive projects:

0

1

2

3

4

5

Project 1	-$250	$55	$55	$55	$190	$190
Project 2	-$650	$300	$300	$40	$40	$40

Which project would you recommend?

Select the correct answer.

a. Neither Project 1 nor 2, since each project's NPV < 0.

b. Project 2, since the NPV2 > NPV1.

c. Both Projects 1 and 2, since both projects have IRR's > 0.

d. Both Projects 1 and 2, since both projects have NPV's > 0.

e. Project 1, since the NPV1 > NPV2.

Answer 1

Project 1

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

• Press the CF button.
• CF0= -$250. 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 weighted average cost of capital of 10%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 10% weighted average cost of capital is $134.52.

Project 2

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

• Press the CF button.
• CF0= -$650. 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 weighted average cost of capital of 10%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 10% weighted average cost of capital is -$47.12

I would recommend project 1 since its net present value is positive and higher than that of project 1.

Hence, the answer is option e.

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