Your company is considering two mutually-exclusive projects. Both require an ini

Question

Your company is considering two mutually-exclusive projects. Both require an initial outlay of $10,000 and will operate for 5 years. Project A will produce expected cash flows of $5,000 per year for years 1 through 5, whereas project B will produce expected cash flows of $6,000 per year for years 1 through 5. Because project B is the riskier of the two projects, management has decided to apply a required rate of return of 15 percent to its evaluation but only a 12 percent required rate of return to project A. Discuss each project’s risk-adjusted net present value

Explanation / Answer

NPV = Present value of cash inflows - Present value of cash outflows

1. NPV of project A = 5,000 x PVAF(12%, 5years) - 10,000 = (5,000 x 3.605) - 10,000 = $8,023.88

2. NPV of project B = 6,000 x PVAF(15%, 5years) - 10,000 = (6,000 x 3.352) - 10,000 = $10,112.93

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