We are trying to choose between two projects A and B. They both provide cash flo

Question

We are trying to choose between two projects A and B. They both provide cash flows over a two year period. The cost of project A is $1000 at time zero. The cost of project B is $1400 at time zero. The simple annual risk free interest rate is 5%. The net present value of the cash flows for project A is $1,000. The net present value of the cash flows for project B is $750. However, project B is flexible. I can adjust the scale of the project B up or down by 50% either by buying additional assets at a cost of $700 or by selling some of its assets at a constant revenue of $700 at any time over the next two years. The volatility for both projects 40% per annum. Which project is better? Show all work. You may use any approach to solve this problem.

Explanation / Answer

i will use the NPV rule, in choosing between both of these projects,

if comparing between two projects we find that the one project with a NPV , that is higher in comparison to the other project, We choose the project with a higher NPV. There are certain advantages of project B over project A, but at the end , the numbers indicate that the project A is better as it is creating value for the business. The initial investment on project A is also lower in comparison to project B.

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