Project S requires an initial outlay at t = 0 of $13,000, and its expected cash flows would be $6,000 per year for 5 years. Mutually exclusive Project L requires an initial outlay at t = 0 of $33,000, and its expected cash flows would be $8,750 per year for 5 years. If both projects have a WACC of 12%, which project would you recommend?
Select the correct answer.
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S:
Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate
=6000[1-(1.12)^-5]/0.12
=6000*3.6047762
=21628.66
NPV=Present value of inflows-Present value of outflows
=21628.66-13000
=$8628.66(Approx).
L:
Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate
=8750[1-(1.12)^-5]/0.12
=8750*3.6047762
=31541.79
NPV=Present value of inflows-Present value of outflows
=31541.79-33000
=$(1458.21)(Approx).(Negative).
Hence S must be selected having higher and positive NPV
Hence the correct option is:
a. Project S, since the NPVS > NPVL
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