Consider Projects A and B, with net cash flows as follows: ---- Net Cash Flows -

Question

Consider Projects A and B, with net cash flows as follows:

---- Net Cash Flows ----

                                 Project A            Project B

            Initial Cost at T-0 (Now)               ($30,000)              ($50,000)

cash inflow at the end of year 1        10,000                   6,000

cash inflow at the end of year 2          8,000                 16,000

cash inflow at the end of year 3          5,000                 25,000

a. Construct NPV Profiles for these two projects.

b. If the two projects were mutually exclusive, which would you accept if your firm’s cost of capital were 4%? Which would you accept if your firm’s cost of capital were 8%?

Explanation / Answer

a. Construct NPV Profiles for these two projects.

b. If the two projects were mutually exclusive, which would you accept if your firm’s cost of capital were 4%? Which would you accept if your firm’s cost of capital were 8%?

Solution

Using  if your firm’s cost of capital were 4%

Project A

NPV = -30000 + 10000/1.04 + 8000/1.04^2 + 5000/1.04^3

NPV = - $ 8543.18

Project B

NPV = -50000 + 6000/1.04 + 16000/1.04^2 + 25000/1.04^3

NPV = - $ 7212.96

Decision : Both project should be rejected as its NPV is negative

Using  if your firm’s cost of capital were 8%

Project A

NPV = -30000 + 10000/1.08 + 8000/1.08^2 + 5000/1.08^3

NPV = - $ 9912.87

Project B

NPV = -50000 + 6000/1.08 + 16000/1.08^2 + 25000/1.08^3

NPV = - $ 10881.20

Decision : Both project should be rejected as its NPV is negative

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