Question

Problem 11-11 Capital budgeting criteria: mutually exclusive projects Project S costs $16,000 and its expected cash flows would be $5,500 per year for 5 years. Mutually exclusive Project L costs $35,500 and its expected cash flows would be $8,600 per year for 5 years. If both projects have a WACC of 16%, which project would you recommend? Select the correct answer. O I. Project S, since the NPVs > NPVL. O II. Both Projects S and L, since both projects have NPV's > 0. O III. Project L, since the NPVL > NPVS. O IV. Neither Sor L, since each project's NPV < 0. O V. Both Projects S and L, since both projects have IRR's > 0.

Answer 1

Since projects are mutually exclusive, we choose the project having the highe NPV

Project S:

NPV = Present value of cash inflows - present value of cash outflows

NPV = Annuity * [1 - 1 / (1 + r)ⁿ]/r - Initial investment

NPV = 5500 * [1 - 1 / (1 + 0.16)⁵]/ 0.16 - 16,000

NPV = 5500 * [1 - 0.476113] / 0.16 - 16,000

NPV = 5500 * 3.274294 - 16,000

NPV = $2,008.62

Project L:

NPV = Present value of cash inflows - present value of cash outflows

NPV = Annuity * [1 - 1 / (1 + r)ⁿ]/r - Initial investment

NPV = 8600 * [1 - 1 / (1 + 0.16)⁵]/ 0.16 - 35,500

NPV = 8600 * [1 - 0.476113] / 0.16 - 35,500

NPV = 8600 * 3.274294 - 35,500

NPV = -7,341.07

Project S, since the NPVs > NPVL