Question

You are considering two independent projects that have differing requirements. Project A has a required return of 12 percent compared to Project B’s required return of 13.5 percent. Project A costs $75,000 and has cash flows of $21,000, $49,000, and $12,000 for Years 1 to 3, respectively. Project B has an initial cost of $70,000 and cash flows of $15,000, $18,000, and $41,000 for Years 1 to 3, respectively. Given this information, you should:
1. accept both Project A and Project B.
2. accept Project A and reject Project B.
3. accept Project B and reject Project A.
4. reject both Project A and Project B.
5. accept whichever one you want but not both.

Answer 1

Answer:

4. reject both Project A and Project B.

their NPV are negative so are not profitable.

Explanation:

We have to calculate the present value of the projects at their return rate

Project A

Present value of the cash flow - investment = net present value

$\frac{21,000}{(1.12)^{1} } = PV$

$\frac{49,000}{(1.12)^{2} } = PV$

$\frac{12,000}{(1.12)^{3} } = PV$

-75,000 + PV 21,000 + PV 49,000 + PV 12,000

-75,000 + 18,750 + 39062.5 + 8,541.36 = -8646.14

Project B

Present value of the cash flow - investment = net present value

-70,000 + PV 15,000 + PV 18,000 + PV 41,000

$\frac{15,000}{(1.135)^{1} } = PV$

$\frac{18,000}{(1.135)^{2} } = PV$

$\frac{41,000}{(1.135)^{3} } = PV$

-70,000 + 13215.86 + 13972.71 + 28041.18 = -14770.25