Question

John is evaluating two mutually exclusive capital budgeting projects that have the following characteristics: 1 Cash Flows Year Project Project R 0 $(10,000) $(10,000) 0 5,000 2 0 5.000 3 0 5,000 4 22,000 5,000 1) Calculate NPV of each project if the firm's required rate of return (1) is 9 percent. 2) which project should be purchased? >

Answer 1

NPV = Present value of all the future cash inflow discounted at required rate of return - initial outlay

1)

Project Q:

NPV = 22000/(1+ 0.09)^4 - 10000

= $5585.35 Answer

Project R:

NPV = 5000/(1+ 0.09)^1 + 5000/(1+ 0.09)^2 + 5000/(1+ 0.09)^3 + 5000/(1+ 0.09)^4 - 10000

= $6198.60 Answer

2)

Since NPV of project R is higher than project Q, we should purchase project R.

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