Answer:
The NPV for Project A is 3.291 and Project B is 3.56
Explanation:
In this question, we have to use the net present value formula which is shown below:
Net present value = Present value of all years cash flows - Initial investment
where,
Present value of cash inflows is calculated by applying the discount rate which is presented below:
For this, we have to first compute the present value factor which is computed by a formula
= 1 ÷ (1 +rate) ∧ number of year
number of year = 0
number of year = 1
Number of year = 2
number of year = 3
So,
Rate = 5%
For year 1 = 0.9524 (1 ÷ 1.05) ∧ 1
For year 2 = 0.9070 (1 ÷ 1.05) ∧ 2
For year 3 = 0.8638 (1 ÷ 1.05) ∧ 3
Now, multiply this present value factor with yearly cash inflows
So
For Project A,
The present value of year 1 = $5 × 0.9524 = $4.762
The present value of year 2 = $9 × 0.9070 = $8.163
The present value of year 3 = $12 × 0.8638 = $10.366
and the sum of all year cash inflow is $23.291
So, the Net present value would be equal to
= $23.291 - $20 = 3.291
And,
For Project B
The present value of year 1 = $8 × 0.9524 = $7.619
The present value of year 2 = $7 × 0.9070 = $6.349
The present value of year 3 = $3 × 0.8638 = $2.592
and the sum of all year cash inflow is $16.560
So, the Net present value would be equal to
= $16.560 - $13 = 3.56
Hence, the NPV for Project A is 3.291 and Project B is 3.56
