Suppose your firm is considering two mutually exclusive, required projects with

Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively. Time 0 Project A34,000 24,000 44,000 15,000 Cash Flow Cash Flow Use the NPV decision rule to evaluate these projects; which one(s) should it be accepted or rejected? Project B 44000 24,000 34.000 64.000 O accept neither A nor B Oaccept both A and B O reject A, accept B O accept A, reject B

Explanation / Answer

Calculation of NPV of Project A and Project B Year Discount factor @ 12% Project A Project B Cash Flows Present Values Cash Flows Present Values 0    1.00000 -$34,000.00 -$34,000.00 -$44,000.00 -$44,000.00 1    0.89286 $24,000.00 $21,428.57 $24,000.00 $21,428.57 2    0.79719 $44,000.00 $35,076.53 $34,000.00 $27,104.59 3    0.71178 $15,000.00 $10,676.70 $64,000.00 $45,553.94 NPV $33,181.81 $50,087.10 The NPV of project B is higher than project A. Hence Project B should be selected. The answer is 'reject A, accept B'

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