Question

0. Mutually Exclusive Investments. Here are the cash flow forecasts for two mutually exclu sive projects Cash Flows Dollars Yar Project A Project B $100 30 50 70 $100 49 49 49 a Which project would you choose if the opportunity cost of capital is 2 percent b. Which would you choose if the opportunity cost of capital is 12 percene e. Why does your answer change?

Answer 1

Answer a:

If opportunity cost of capital = 2%, Project A will be selected.

Workings:

Answer b:

If opportunity cost of capital = 12%, Project B will be selected.

NPV when cost of capital: 296 |Rank Project A Project B $16.47 $17.69 2 1 Selected

Answer c:

Answer changes because:

Project B' cash flow is uniform over 3 years whereas Project A's cash flows are lower initially and then increases with highest in the last year. NPV assumes reinvestment of cash flows at the rate of cost of capital.