Project A has cash flows of -$74,900, $18,400, $26,300, and $57,100 for years 0
ID: 2776682 • Letter: P
Question
Project A has cash flows of -$74,900, $18,400, $26,300, and $57,100 for years 0 to 3, respectively. Project B has cash flows or -$79,000, $18,400, $22,700, and $51,500 for years 0 to 3 respectively. Both projects are independent and use straight line depreciation to a zero balance over the project life. Neither project has any salvage value and both have a required accounting return of 11.5 percent. Should you accept or reject these projects based on the average accounting return?
A. Accept Project A and reject Project B
B. Reject Project A and accept Project B
C. Accept both projects
D. Reject both projects
E. The AAR cannont be computed
Explanation / Answer
Correct option is > A. Accept Project A and reject Project B
Reason: NPV of project is positive and NPV of project is negative hence, as per decision rule we should accept project A and reject project B
Working demonstrated below:
For Project A
Discount rate = WACC = R = 11.5%
Present Values
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$74,500.00
1.000000
-$74,500.00
1
$18,400.00
0.896861
$16,502.24
2
$26,300.00
0.804360
$21,154.66
3
$57,100.00
0.721399
$41,191.87
Net Present Value = Total of Present Values =
$4,348.77
For project B
Discount rate = WACC = R = 11.5%
Present value = Df x Cash flows
Year
Cash flows
Discount factor = Df = 1/(1+R)^Year
PV of cash flows
0
-$79,000.00
1.000000
-$79,000.00
1
$18,400.00
0.896861
$16,502.24
2
$22,700.00
0.804360
$18,258.96
3
$51,500.00
0.721399
$37,152.04
Total of PV = NPV =
-$7,086.76
Discount rate = WACC = R = 11.5%
Present Values
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$74,500.00
1.000000
-$74,500.00
1
$18,400.00
0.896861
$16,502.24
2
$26,300.00
0.804360
$21,154.66
3
$57,100.00
0.721399
$41,191.87
Net Present Value = Total of Present Values =
$4,348.77
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