Answer:
Project B is a better investment
Explanation:
Given:
Project A's initial investment is $500,000
Expected cash inflow starting from year 1 for 5 years is $150,000
Required rate of return is 10% and inflation is 3%. So required rate of return is 13%
NPV of project A = -500,000 + Present value of annuity of $150,000, 5 years at 13%
Present value of annuity factor of $1, 13%, 5 periods = 3.5172
NPV of project A = -500,000 + (150,000 × 3.5172)
= $27,580
Poject B's initial investment = $400,000
Use present value factor of $1, 13% to compute present value of cash inflows:
Year 1 = 0
Year 2 = 50,000 × 0.7831 = 39,155
Year 3 = 200,000 × 0.6931 = 138,620
Year 4 = 300,000 × 0.6133 = 183,990
Year 5 = 200,00 × 0.5428 = 108,560
NPV of project B = -400,000 + (39,155 + 138,620 + 183,990 + 108,560)
= $70,325
Since project B's NPV is higher than project A, project B is a better investment.
