Question

legacy manufacturing has a 10% cost of capital, and has generated the following information on two mutually exclusive projects

Year	Project A	Project B
0	-$110,000	-$90,000
1	$50,000	$40,000
2	$50,000	$40,000
3	$50,000	$40,000
4	$50,000	$40,000

A compute the net present value (NPV) for project A?

B. Compute the (NPV) for project B?

C. Which project should Legacy adopt? Why?

Answer 1

Project A)

Using NPV formula,

NPV = CF0+CF1/(1+r¹)+ CF1/(1+r²)+ ....................+ CF1/(1+rⁿ)

NPV = -110000 + 50000/(1+0.1)¹+ 50000/(1+0.1)²+50000/(1+0.1)³+50000/(1+0.1)⁴

= -110000+50000(1/(1+0.1)¹+ 1/(1+0.1)²+1/(1+0.1)³+1/(1+0.1)⁴)

= -110000+50000(0.909+0.8264+0.751+0.683) = 48470 approx.

Project B)

NPV = -90000 + 40000/(1+0.1)¹+ 40000/(1+0.1)²+40000/(1+0.1)³+40000/(1+0.1)⁴

^{= 36776 approx.}

^{C) Since the NPV of the project A is more, we should adopt project A}