Atlas Corp is considering two mutually exclusive projects. Both require an initi

Question

Atlas Corp is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t=0. Project S has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,000 at the end of Years 1 and 2, respectively. Project L has an expected life of 4 years with after-tax cash inflows of $4,373 at the end of each of the next 4 years. Each project has a WACC of of 10.75%, and Project S can be repeated with no changes in its cash flows. The controller prefers Project S, but the CFO prefers Project L. how much value will the firm gain or lose if Project L is selected over Project S, i.e., what is the value of NPV(L) - NPV(S)?

Explanation / Answer

PV of project S: NPV = -10,000 + 6,000/1.1075 + 8,000/1.1075^2 NPV = 1,939.93 Since this project can be performed twice we know that the PV of the first project in year 0 is 1,939.93 and this will also be the PV in year 2 (start of the second round) this value has to be discounted back to now. NPVs = 1,939.93 + 1,939.93/1.1075^2 = 1,939.93 + 1,581.60 = 3,521.53 PV of project L NPV = -10,000 + 4,373/1.1075 + 4,373/1.1075^2 + 4,373/1.1075^3 + 4,373/1.1075^4 NPV = 3,639.73 So project L is the better choice. Gain of L over S = 3,639.73 - 3,521.53 = 118.20

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