Your company has a cost of capital equal to 10%. If the following projects are m
ID: 2648252 • Letter: Y
Question
Your company has a cost of capital equal to 10%. If the following projects are mutually exclusive, and you only have the information that is provided, which should you accept?
A
B
C
E
1
5
2
5
18%
20%
20%
12%
$40
$75
$35
$100
A
B
C
B and C
E
As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:
Project X
Project Z
Year
Cash Flow
Cash Flow
0
-$100,000
-$100,000
1
50,000
10,000
2
40,000
30,000
3
30,000
40,000
4
10,000
60,000
If Denver's cost of capital is 15 percent, which project would you choose?
Neither project.
Project X, since it has the higher IRR.
Project Z, since it has the higher NPV.
Project X, since it has the higher NPV.
Project Z, since it has the higher IRR.
Two projects being considered are mutually exclusive and have the following projected cash flows:
Project A
Project B
Year
Cash Flow
Cash Flow
0
-$50,000
-$50,000
1
15,625
0
2
15,625
0
3
15,625
0
4
15,625
0
5
15,625
99,500
If the required rate of return on these projects is 10 percent, which would be chosen and why?
Project B because it has the higher NPV.
Project B because it has the higher IRR.
Project A because it has the higher NPV.
Project A because it has the higher IRR.
Neither, because both have IRRs less than the cost of capital.
A
B
C
E
Payback (years)1
5
2
5
IRR18%
20%
20%
12%
NPV (Millions)$40
$75
$35
$100
Explanation / Answer
ANSWER 1 : e that is Project 'E'.
Mutually exclusive means that only one project in a set of possible projects can be accepted and that the projects compete with each other. If projects A and B were mutually exclusive, the firm could accept either Project A or Project B , but not both.
In case of mutually exclusive projects , One should always prefer to select the project with Highest positive NPV and avoid IRR method.
So Answer to the first question is "e" that is Project 'E'.
ANSWER 2 : a - Neither Project
Project X has NPV = $ -832.97 ( which is negative ) and IRR = 14.48 % ( which is < Cost of capital ) => Never select Project X
Project Z has NPV = $ -8014.19 ( which is negative ) and IRR = 11.79 % ( which is < Cost of capital ) => Never select Project Z
Answer 3: a - Project B because it has higher NPV.
Project A has NPV = $ 9231.04 ( Which is positive ) & IRR = 17 % ( Which is higher than Required Rate of return )
Project B has NPV = $ 11781.67 ( Which is positive ) & IRR = 14.75 % ( Which is higher than Required Rate of return )
We must select project B, as the projects are mutually exclusive and Project B has higher positive NPV ( We will not compare IRR in this case ).
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