Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of cap

Question

Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of capital of 9 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 $ 391 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 $ 248 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.

Explanation / Answer

NPV is calculated by discounting the cashflows

PV = C/(1+r)^n

C - Cashflow

r - Discount rate

n - years to the cashflow

Project A:

Cost of capital = 9 + 1 = 10%

NPV = -391 + 101/(1+0.1)^1 + 101/(1+0.1)^2 + 101/(1+0.1)^3 + 101/(1+0.1)^4 = -70.84

NPV = -$70.84

Project B:

Cost of capital = 9 - 1 = 8%

NPV = -391 + 0/(1+0.08)^1 + 0/(1+0.08)^2 + 248/(1+0.08)^3 + 248/(1+0.08)^4 = -11.84

NPV = -$11.84

NPV of the higher NPV project = $-11.84

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