Complete question:
Project A has an initial cost of $80,000 and provides cash inflows of $34,000 a year for three years. Project B has an initial cost of $80,000 and produces a cash inflow of $114,000 in year 3. The projects are mutually exclusive. Which project(s) should you accept if the discount rate is 11.7 percent? What if the discount rate is 13.5 percent?
A. Accept A as it always has the higher NPV.
B. Accept B as it always has the higher NPV.
C. Accept A at 11.7 percent and B at 13.5 percent.
D. Accept B at .11.7 percent and A at 13.5 percent.
E. Accept A at 11.7 percent and neither at 13.5 percent.
Answer:
Accept A at 11.7 percent and neither at 13.5 percent.
Solution:
Using a financial calculator to solve the problem :
For project A with a discount rate of 11.7%
Outlay = 80,000
CF for year 1 = 34000
CF for year 2 = 34000
CF for year 3 = 34000
I = 11.7 %
NPV = 2085
For project A with a discount rate of 13.5%
Outlay = 80,000
CF for year 1 = 34000
CF for year 2 = 34000
CF for year 3 = 34000
I = 13.5%
NPV = -397.5
For project B with a discount rate of 11.7%
Outlay = 80,000
CF for year 1 = 0
CF for year 2 = 0
CF for year 3 = 114,000
NPV = 1798
For project B with a discount rate of 13.5%
Outlay = 80,000
CF for year 1 = 0
CF for year 2 = 0
CF for year 3 = 114,000
NPV = -2,032
From the above calculations, Accept A at 11.7 percent and neither at 13.5 percent.
