Two mutually exclusive projects are under consideration. Year Project A Project

Question

Two mutually exclusive projects are under consideration.

Year          Project A                          Project B

0                -$5,000                            -$9,000

1                 $2,750                               $1,000

2                 $2,750                              $3,000

3                 $2,750                              $5,000

4                 $2,750                               $7,000

5                 $2,750                              $9,000

(a) Which project should be selected if the simple payback method is used to make the

determination?

(b) Which project should be selected if NPW or NFW were used? Consider the time value

of money to be 15%.

(c) Explain any differences in results.

Explanation / Answer

a) If the simple payback method is used, Project A is selected.

b) if NPV is used, Project B is used as Project B's net present value is higher than Project A's NPV

c) The difference is due to the time value of money where a future dollar is worth less than a dollar today. By discounting cash flows in the future, Project B is better on a present value basis.

A Cumulative Cash Flows B Cumulative Cash Flows -5000 -9000 1 2750 -2250 1000 -8000 2 2750 500 3000 -5000 3 2750 3250 5000 0 4 2750 6000 7000 7000 5 2750 8750 9000 16000 Rate 15% 15% NPV 4218 5902

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