Josh is analyzing two mutually exclusive projects of similar size and has prepra

Question

Josh is analyzing two mutually exclusive projects of similar size and has preprared the following data. Both projects have 5-year lives.

Project A Project B

Net Present Value $15,090 $14.693

Payback Period 2.76 years 2.51 years

Required Return 8.30% 8.00%

Josh has been asked for his best recommendation given this information. His recommendation should be to:
Answer
a.
Accept both projects as they both have positive net present values
b.
Accept neither project
c.
Accept Project B and reject Project A based on their required returns.
d.
Accept Project A and reject Project B based on their net present values.
e.
Accept Project B because it has the shortest payback period.

Explanation / Answer

The decision criteria should be based on both Net present value and the IRR values. According to NPV decision rule, though both the projects have positive NPV's , project-A has highest NPV value and hence it should be accepted. According to PAyback period decision rule, the project with less payback period should be accepted. Though the payback period for project -B is less, but based on NPV rule project-A should be accepted. The correct option is d) Accept project-A and reject project-B based on their Net present values. Since the projects are mutually exclusive either of the projects should be accepted.

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