Question

1. As the director of capital budgeting for KU dairy, you are evaluating two mutually exclusive projects with the following net cash flows:

Year	Project A Cash Flow	Project B Cash Flow
0	-100,000	-100,000
1	50,000	10,000
2	40,000	30,000
3	30,000	40,000
4	10,000	60,000

If KU’s cost of capital is 15%, examine which project you would choose?

Answer 1

We will choose the project which has the higher NPV

Project A:

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

NPV = -100,000 + 50,000 / (1 + 0.15)¹ + 40,000 / (1 + 0.15)² + 30,000 / (1 + 0.15)³ + 10,000 / (1 + 0.15)⁴

NPV = -100,000 + 43,478.26087 + 30,245.74669 + 19,725.48697 + 5,717.53246

NPV = -832.97

Project B:

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

NPV = -100,000 + 10,000 / (1 + 0.15)¹ + 30,000 / (1 + 0.15)² + 40,000 / (1 + 0.15)³ + 60,000 / (1 + 0.15)⁴

NPV = -100,000 + 8,695.6522 + 22,684.31002+ 26,300.6493 + 34,305.19474

NPV = -8,014.19

Both projects should be REJECTED as both have negative NPVs