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 11 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 $ 396 and will last 4 years. Project A, a riskier-than-average project, will produce annual end of year cash flows of $ 92 . Project B, of less than average risk, will produce cash flows of $ 312 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

More Riskier Project

CF0 = -396

CF1 = 92

CF2 = 92

CF3 = 92

CF4 = 92

Discount Rate = 11% + 1% = 12%

NPV = -396 + 92/ (1.12)1 + 92/ (1.12)2 + 92/ (1.12)3 + 92/ (1.12)4

NPV = -396 + 82.14 + 73.34 + 65.48 + 58.47

NPV = -116.56

Less Riskier Project

CF0 = -396

CF1 = 0

CF2 = 0

CF3 = 312

CF4 = 312

Discount Rate = 11% - 1% = 10%

NPV = -396 + 0/ (1.1)1 + 0/ (1.12)2 + 3122/ (1.1)3 + 312/ (1.1)4

NPV = -396 + 0 + 0 + 234.41 + 213.10

NPV = 51.51

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