Question

Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of capital of 8 percent to evaluate average-risk projects, and it adds or subtracts 1 percentage points to evaluate projects of more or less risk. Currently, two mutually exclusive projects are under consideration. Both have a cost of $ 303 and will last 4 years. Project A, a riskier-than-average project, will produce annual end of year cash flows of $ 101 . Project B, of less than average risk, will produce cash flows of $ 272 at the end of Years 3 and 4 only. To the nearest .01, list the NPV of the higher NPV project. Note, if the NPV is negative, place a - sign in front of your answer. Do not use the $ symbol.

Answer 1

From Above Statement, "uses a cost of capital of 8 percent to evaluate average-risk projects, and it adds or subtracts 1 percentage points to evaluate projects of more or less risk." its clear that the

Cost of Capital for Average Risk Product = 8.00%

Cost of Capital for More Risk Product = 8.00% + 1.00%

= 9.00%

Cost of Capital for Less Risk Product = 8.00% - 1.00%

Project A is riskier-than-average, so its cost of capital = 9.00%

Project B, of less than average risk, so its cost of capital = 7.00%

Cost of Both project = $303

NPV Calculation will be as below

As per above calculation, NPV of Project A = 24.21

NPV of Project B = 126.54

So project B is having higher NPV.