Problem 11-11 Capital budgeting criteria: mutually exclusive projects Project S
ID: 2801572 • Letter: P
Question
Problem 11-11
Capital budgeting criteria: mutually exclusive projects
Project S costs $18,000 and its expected cash flows would be $6,500 per year for 5 years. Mutually exclusive Project L costs $38,500 and its expected cash flows would be $10,500 per year for 5 years. If both projects have a WACC of 14%, which project would you recommend?
Select the correct answer.
I. Both Projects S and L, since both projects have IRR's > 0. II. Project L, since the NPVL > NPVS. III. Both Projects S and L, since both projects have NPV's > 0. IV. Project S, since the NPVS > NPVL. V. Neither S or L, since each project's NPV < 0.Explanation / Answer
Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)
S:
Present value of inflows=6500/1.14+6500/1.14^2+........+6500/1.14^5
=$22315.03
NPV=Present value of inflows-Present value of outflows
=22315.03-18000
=$4315.03
L:
Present value of inflows=10500/1.14+10500/1.14^2+.............+10500/1.14^5
=$36047.35
NPV =$36047.35-$38500
=($2452.65)
Hence since projects are mutually exlusive;project having higher NPV must be selected.
Hence the correct option is 4.