Big Company is evaluating two projects, Project A and Project B. Both projects a
ID: 2802054 • Letter: B
Question
Big Company is evaluating two projects, Project A and Project B. Both projects are of equal risk. Big Company has a WACC of 10%. The expected free cash flows of the projects are as follows
A. Compute the Net Present Value of Project “A”
B. The Net Present Value of Project “B” is $11,554.88. If projects “A” and “B” are independent, considering only at the NPV method, which projects(s) should Big Company proceed with? Explain your answer.
C. The Net Present Value of Project “B”: is $11,554.88 ”A” and “B” are mutually exclusive, considering only at the NPV method, which project(s) should Big Company proceed with? Explain your answer
Period Annual Cash Flows Project A Annual Cash Flows Project B 0 (25,000) (25,000) 1 5,000 20,000 2 10,000 10,000 3 15,000 8,000 4 20,000 6,000Explanation / Answer
Project A cashflows:
CF0 = -25,000
CF1 = 5,000
CF2 = 10,000
CF3 = 15,000
CF4 = 20,000
Discount Rate = 10%
NPV = -25,000 + 5,000/ (1.1) + 10,000/ (1.1)2 + 15,000/ (1.1)3 + 20,000/ (1.1)4
NPV = -25,000 + 4,545.45 + 8,264.46 + 11,269.72 + 13,660.27
NPV = 12,739.91
NPV of project A is 12,739.91
Part B
As given, both projects are independent it implies firm can accept both the projects. Independent projects are those projects which are not affected by the cash flows of other projects.
NPV of both A and B is positive, so firm can accept both the projects.
Part C
As given, both projects are mutual exclusive it implies firm can only accept a single project. In mutual exclusive projects in which selection of one project lead to exclusion of other projects.
As NPV of project A is more than project B, we will choose project A as it will add more value to the company.
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