Suppose your firm is considering two mutually exclusive, required projects with

Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 9 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively.

Use the NPV decision rule to evaluate these projects; which one(s) should be accepted or rejected?

  Time: 0 1 2 3   Project A Cash Flow -26,000 16,000 36,000 7,000   Project B Cash Flow -36,000 16,000 26,000 56,000

Explanation / Answer

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

A:

Present value of inflows=16000/1.09+36000/1.09^2+7000/1.09^3

=$50384.66

NPV=Present value of inflows-Present value of outflows

=50384.66-26000=$24384.66

B:

Present value of inflows=16000/1.09+26000/1.09^2+56000/1.09^3

=$79804.85

NPV =$79804.85-$36000=$43804.85

Hence since projects are mutually exclusive;B must be preferred having higher NPV.

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