Question

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?

Answer 1

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