Question

Your company is trying to decide which one of two projects it should accept. Both projects have the same start-up costs. Project 1 will produce annual cash flows of $52 000 at the end of each year for six years. Project 2 will produce cash flows of $39 000 at the beginning of each year for eight years. The company requires a 15% return. Required:
a. Which project should the company select and why?

b. Which project should the company select if the interest rate is 12% at the cash flows in Project 2 is also at the end of each year?

Answer 1

Answer:

a)Project 2 should be selected

b) Project 1 should be selected

Explanation:

We would compute the  Present Value(PV) of the cash inflows from the  the two projects and compare them.

PV of cash inflow = A × (1- (1+r)^(-n)/r

A-cash inflow, r- required return, n - number of years

Project A = 52,000× (1 - 1.15^(-6)/0.15= 196,793.1

Project 2= 39,000 + ((1 - 1.15^-7)/0.15= 201,256.36

Project 2 should be selected

Project 1 = 52,000× (1 - 1.12^(-6)/0.15=213,793.1808

Project 2= 39,000 + ((1 - 1.12^-8)/0.15= 193,737.9509

Project 1 should be selected