1. Determine the NPV for both projects using a cost of capital of 13% 2. Determi

Question

1. Determine the NPV for both projects using a cost of capital of 13% 2. Determine the NPV for both projects using a cost of capital of 8% 3. At an 8% discount rate, which project should be accepted? at 13% discount rate, which project should be accepted? Explain

Given (in thousands):

Initial investment of $6,500.00

Net operating cash flows for project X - $5,000 (1YR), $3,000 (YR2), $2,000 (3), $1600 (4), $1000 (5)

Net operating cash flow for project Y - $1,000 (YR1), $1600 (2), $2000 (3), $3000 (4), 5000 (5)

Explanation / Answer

At discount rate of 13%

NPV for X at 13% = -6,500 + 5,000/1.13^1 + 3,000/1.13^2 + 2,000/1.13^3 + 1,600/1.13^4 + 1,000/1.13^5 = 3,184.39

NPV for Y at 13% = -6,500 + 1,000/1.13^1 + 1,600/1.13^2 + 2,000/1.13^3 + 3,000/1.13^4 + 5,000/1.13^5 = 1,577.85

At 13% discount rate, X's NPV is higher (at 3,184.39), hence Project X should be accepted.

At discount rate of 8%

NPV for X at 8% = -6,500 + 5,000/1.08^1 + 3,000/1.08^2 + 2,000/1.08^3 + 1,600/1.08^4 + 1,000/1.08^5 = 4,145.94

NPV for Y at 8% = -6,500 + 1,000/1.08^1 + 1,600/1.08^2 + 2,000/1.08^3 + 3,000/1.08^4 + 5,000/1.08^5 = 2,993.34

At 8% discount rate, X's NPV is higher (at 4,145.94), hence Project X should be accepted.

Hope this helped ! Let me know in case of any queries.

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