Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of cap

Question

Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of capital of 11 percent to evaluate average-risk projects, and it adds or subtracts 2 percentage points to evaluate projects of more or less risk. Currently, two mutually exclusive projects are under consideration. Both have a cost of $ 358 and will last 4 years. Project A, a riskier-than-average project, will produce annual end of year cash flows of $ 84 . Project B, of less than average risk, will produce cash flows of $ 291 at the end of Years 3 and 4 only. To the nearest .01, list the NPV of the higher NPV project. Note, if the NPV is negative, place a - sign in front of your answer. Do not use the $ symbol.

Explanation / Answer

Find the NPV of both the projects:

NPV is calculated by discounting the cashflows

PV = C/(1+r)^n

C - Cashflow

r - Discount rate

n - years to the cashflow

Project A:

Cost of capital = 11%+2% = 13%

NPV of project A = -108.14

Project B:

Cost of capital = 11%-2% = 9%

NPV of project B = 72.86

NPV of the higher project is, project B = 72.86

Rate 13.00% Year Cashflow (A) Discount rate = 1/(1+r)^(n) Present value of cashflow = A*discount rate 0 -358.00 1.00 -358.00 1 84.00 0.88 74.34 2 84.00 0.78 65.78 3 84.00 0.69 58.22 4 84.00 0.61 51.52 NPV -108.14

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