CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS A firm with a WACC of 10
ID: 2797761 • Letter: C
Question
CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS A firm with a WACC of 10% is considering the following mutually exclusive projects: 0 1 2 3 4 5 Project 1 -$350 $50 $50 $50 $210 $210 Project 2 -$650 $250 $250 $65 $65 $65
Which project would you recommend? Select the correct answer.
a. Both Projects 1 and 2, since both projects have IRR's > 0.
b. Neither Project 1 nor 2, since each project's NPV < 0.
c. Project 2, since the NPV2 > NPV1.
d. Both Projects 1 and 2, since both projects have NPV's > 0.
e. Project 1, since the NPV1 > NPV2.
Explanation / Answer
The Project to be selected to be the one with the higher NPV .
NPV of Project 1:
NPV of Project = Present Value of Cash Inflow - Present Value of cash Outflow
= $ 50 * 1/(1.10) ^ 1 + $ 50 * 1/(1.10) ^2 + $ 50 * 1/(1.10) ^3 + $ 210 * 1/(1.10) ^4 + $210* 1/(1.10) ^5 - $ 350
= $ 48.17
NPV of Project 2:
NPV of Project = Present Value of Cash Inflow - Present Value of cash Outflow
= $ 250 * 1/(1.10) ^ 1 + $ 250 * 1/(1.10) ^2 + $ 65 * 1/(1.10) ^3 + $ 65* 1/(1.10) ^4 + $65 * 1/(1.10) ^5 - $ 650
= - $ 82.52
Hence the correct answer is e. Project 1, since the NPV1 > NPV2
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