Capital budgeting criteria: mutually exclusive projects A firm with a WACC of 10

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 A -$250 $80 $80 $80 $215 $215 Project B -$550 $350 $350 $40 $40 $40 Which project would you recommend? Select the correct answer. I. Project A, since the NPVA > NPVB. II. Neither A or B, since each project's NPV < 0. III. Project B, since the NPVB > NPVA. IV. Both Projects A and B, since both projects have NPV's > 0. V. Both Projects A and B, since both projects have IRR's > 0.

Explanation / Answer

step 1: Calculation of each project's NPV

-Project A

NPV= $229.29 (72.73+66.12+60.11+146.85+133.50-250)

-Project B

NPV = $139.65 (318.18+289.26+30.05+27.32+24.84-550)

Formula to calculate PV in excel is as follows

"=PV(interest rate,Year,0,cashflow)"

You can use the equation Cashflow * 1/(1+i)n to find present value using calculator

Analysis: Since the projects are mutually exclusive,only one project can be selected. So select Project A since it has higher NPV.

Year 0 1 2 3 4 5 Interest Rate 10% 10% 10% 10% 10% 10% Cashflow(in $) -250 80 80 80 215 215 Present Value ($)             (250.00)                 72.73                       66.12                   60.11                 146.85                 133.50

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