Capital budgeting criteria: mutually exclusive projects Project S costs $13,000

Question

Capital budgeting criteria: mutually exclusive projects Project S costs $13,000 and its expected cash flows would be $5,000 per year for 5 years. Mutually exclusive Project L costs $49,000 and its expected cash flows would be $8,500 per year for 5 years. If both projects have a WACC of 15%, which project would you recommend? Select the correct answer.

I. Project L, since the NPVL > NPVS.

II. Both Projects S and L, since both projects have IRR's > 0.

III. Project S, since the NPVS > NPVL.

IV. Both Projects S and L, since both projects have NPV's > 0.

V. Neither S or L, since each project's NPV < 0.

PS. Option I and II are not correct answers.

Explanation / Answer

NPV:
{R x [(1) – (1+i)-n]/(i)} – Initial Investment

Project S:
=> {$5,000 x [(1) – (1+0.15)-5]/(0.15)} – $13,000 = $3,760.78

Project L:
=> {$8,500 x [(1) – (1+0.15)-5]/(0.15)} – $49,000 = -$20,506.68

III. Project S, since the NPVS > NPVL

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