Question

The cash flows for four projects are shown below, along with the cost of capital for these projects. If these projects are mutually exclusive, which one should be taken? $2000 $2000 $2000 $2000 $2000 0 $2500 $2500 $2500 $2500 $2,500 O A. Year: Cash flow: -$5000 Cost of Capital: 6.1% O B. Year: Cash flow: - $6000 Cost of Capital: 7.4% O C. Year: Cash flow: -$7000 Cost of Capital: 7.8% OD. Year: 0 Cash flow: - $8000 Cost of Capital: 9.5% $3000 $3000 $3000 $3000 $3000 $3200 2 $3200 $3200 $3200 $3200

Answer 1

In this question, we need to compute the NPV as shown below

The NPV is computed as follows:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

= Future value / (1 + r)ⁿ

NPV of option A is computed as follows:

= - $ 5,000 + $ 2,000 / 1.061¹ + $ 2,000 / 1.061² + $ 2,000 / 1.061³ + $ 2,000 / 1.061⁴ + $ 2,000 / 1.061⁵

= $ 3,401.86 Approximately

NPV of option B is computed as follows:

= - $ 6,000 + $ 2,500 / 1.074¹ +  $ 2,500 / 1.074² +  $ 2,500 / 1.074³ +  $ 2,500 / 1.074⁴ +  $ 2,500 / 1.074⁵

= $ 4,141.64 Approximately

NPV of option C is computed as follows:

= - $ 7,000 + $ 3,000 / 1.078¹ + $ 3,000 / 1.078² + $ 3,000 / 1.078³ + $ 3,000 / 1.078⁴ + $ 3,000 / 1.078⁵

= $ 5,041.54 Approximately

NPV of option D is computed as follows:

= - $ 8,000 + $ 3,200 / 1.095¹ + $ 3,200 / 1.095² + $ 3,200 / 1.095³ + $ 3,200 / 1.095⁴ + $ 3,200 / 1.095⁵

= $ 4,287.07 Approximately

So, the firm shall select option C, since it has the highest NPV.

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