Given the following cash flows for two mutually exclusive projects, and a requir

Question

Given the following cash flows for two mutually exclusive projects, and a required rate of return of 12%, which of the following statements is true? Year 0 Project A 580,000 290,000 290,000 150,000 150,000 Project B 580,000 130,000 130,000 230,000 230,000 230,000 115,000 2 4 6 O Project B should be accepted because it has the highest NPV. Both projects should be accepted because both have a positive NPV (and EAA) O Project A should be accepted because it has the highest EAA. O Project A should be accepted because it has the highest NPV O Project B should be accepted because it has the highest EAA.

Explanation / Answer

Solution: Statement showing cash flows of project A

0.797

95,250

Total cash inflows(B)= 6,92,150

NPV= Cash inflows (B)-Cash outflows(A)

NPV= 6,92,150-5,80,000= 1,12,150

EAA=NPV/ Cumulative Pvf @12% for 4 years

EAA= 1,12,150/3.037=36,927.89

Statement showing cashflows of project B:

NPV= Total cash inflows (B)- Total cash outflows (A)

NPV=7,18,225 - 5,80,000= 1,38,225

EAA=NPV/Cumulative pvf @12% for 6 years

EAA= 1,38,225/4.111=33,623.21

Advise: Project A should be accepted because it has highest EAA i.e 36,927.89 as compared to project B

Particular year Pvf @12% Amount Present value Cash outflow 0 1 -5,80,000 -5,80,000 Total cash outflow (A) -5,80,000 Cash inflows 1 0.893 2,90,000 2,58,970 Cash inflows 2

0.797

2,90,000 2,31,130 Cash inflows 3 0.712 1,50,000 1,06,800 Cash inflows 4 0.635 1,50,000

95,250

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