Which mutually exclusive project would you select, if both are priced at $1,000 and your required return is 15%: Project A with
three annual cash flows of $1,000; or Project B, with 3 years of zero cash flow followed by 3 years of $1,800 annually?
1 answer:
Answer:
Project B
Explanation:
To select the better project we use the net present value or NPV. This indicates the sum of the present value of all cash flows of a project. To transform a future cash flow into a present cash flow we use a rate, in this case we use the rate of return (15%). Then, we sum all of the cash flows in present value including the investment which negative (because the investment is due in the moment or year 0 we don´t have to transform it into a present value flow).
I attached the NPV formula, but it is better to use excel:
First, we copy all cash flows including the investment with a negative sign. Then we use the finantial formula "NPV" in this way:
For project A
"=NPV(15%;C5:C7)+C4"= $1283,23
For project B
"=NPV(15%;D5:D10)+D4"= $1702,26
We choose the project with the greatest NPV, in this case project B
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