Question

Suppose a company has two mutually exclusive projects, both of which are three years in length. Project A has an initial outlay of $7,000 and has expected cash flows of $2,000 in year 1, $4,000 in year 2, and $5,000 in year 3. Project B has an initial outlay of $8,000 and has expected cash flows of $2,000 in year 1, $3,000 in year 2, and $6,000 in year 3. The required rate of return is 16% for projects at this company. What is the net present value for the best project? (Answer to the nearest dollar.)

Answer 1

A:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=2000/1.16+4000/1.16^2+5000/1.16^3

=$7900.08

NPV=Present value of inflows-Present value of outflows

=$7900.08-$7000

=$900.08(Approx).

B:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=2000/1.16+3000/1.16^2+6000/1.16^3

=$7797.57

NPV=Present value of inflows-Present value of outflows

=$7797.57-$8000

=$(202.43)(Approx).(Negative).

Hence A is the best project having higher NPV of $900(Approx).