2) Consider two mutually exclusive projects. Project A costs $250,000 and produc

Question

2) Consider two mutually exclusive projects. Project A costs $250,000 and produces net cash flows of $70,000 in year 1, $80,000 in year 2, $90,000 in year 3, and $70,000 in year 4. Project B costs $400,000 and produces net cash flows of $85,000 in year 1, $90,000 in year 2, $90,000 in year 3, $120,000 in year 4 and $130,000 in year 5.

a) If the appropriate discount rate is 7%, what project would be more desirable using the NPV criteria?

b) If the appropriate discount rate is 8%, what project would be more desirable using the NPV criteria?

c) What is the crossover discount rate for project A and B?

Explanation / Answer

answer 2)

a) If the appropriate discount rate is 7%,

NPVA = (-250000) + (70000 * 0.935) + (80000 * 0.873) + (90000 * 0.816) + (70000 * 0.763) = $12140

NPVB = (-400000) + (85000 * 0.935) + (90000 * 0.873) + (90000 * 0.816) + (120000 * 0.763)

+ (130000 * 0.713) = $15735

Project B is more desirable.

b) If the appropriate discount rate is 8%,

NPVA = (-250000) + (70000 * 0.926) + (80000 * 0.857) + (90000 * 0.794) + (70000 * 0.735) = $6290

NPVB = (-400000) + (85000 * 0.926) + (90000 * 0.857) + (90000 * 0.794) + (120000 * 0.735)

+ (130000 * 0.681) = $4030

Project A is more desirable.

c) the crossover discount rate for project A and B= 8% + (6290 -4030) / 6290 = 8.36%

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