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 8 percent to evaluate average-risk projects, and it adds or subtracts 3 percentage points to evaluate projects of more or less risk. Currently, two mutually exclusive projects are under consideration. Both have a cost of $ 325 and will last 4 years. Project A, a riskier-than-average project, will produce annual end of year cash flows of $ 99 . Project B, of less than average risk, will produce cash flows of $ 297 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

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 = 8 % + 3% = 11%

NPV = -325 + 99/(1+0.11)^1 + 99/(1+0.11)^2 + 99/(1+0.11)^3 + 99/(1+0.11)^4 = -$17.86

Project B:

Cost of capital = 8% - 3% = 5%

NPV = -325 + 297/(1+0.05)^3 + 297/(1+0.05)^4 = $175.90

Higher NPV is for the project B, NPV = $175.90

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