Question

(Preferred: Please provide Excel formulas when calculating this problem; not the tables)

Consider two projects, A and B. The present value (PV) of after-tax cash inflows for project A is $55,000, while the original investment outlay for this project is $50,000. Project B, on the other hand, has the following characteristics: PV of after-tax cash inflows = $24,000; original investment outlay = $20,000. Assume that these two projects are mutually exclusive and that the company has adequate capital to fund either investment option. All the following statements are true except:

Multiple Choice:

(A) The NPV of Project A is $5,000.

(B) The IRR of Project A is greater than the cost of capital (discount rate).

(C) The profitability index (PI) for Project A is 1:1.

(D) Project A is preferable to Project B (all else held constant).

(E) The economic rate of return on Project A exceeds the discount rate.

Answer 1

(A) NPV of Project A= $55000-$50000= $5000 hence this statement is true.

(B) If NPV is positive then IRR is tend to higher than the cost of capital of the project. Hence, this option is also true.

(D) Project A is preferable over project B as NPV of Project A is $1000 higher than NPV of Project B.

(E) If NPV is positive then economic rate of return is tend to higher than the cost of capital of the project. Hence, this option is also true.

(C) The answer of this multiple choice question is option "C" as Profitability index for project A is 1.1 instead of 1:1 which is as under:

=55000/50000

=1.1