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Project A has an initial cost of $80,000 and provides cash inflows of $34,000 a year for three years. Project B has an initial cost of $80,000 and produces a cash inflow of $114,000 in year 3. The projects are mutually exclusive. Which project(s) should you accept if the discount rate is 11.7 percent?

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Answer:

                        PROJECT A

Year Cashflow DF@11.7    PV

           $

0        (80,000)            1  (80,000)

1-3        34,000  2.4145 82,093

            NPV   2,093

                        PROJECT B

Year Cashflow DF@11.7         PV

             $                     $

0        (80,000)            1  (80,000)

1-3         114,000       2.4145       275,253

         NPV         195,253

Project B should be accepted because it has the higher NPV

Explanation:

The two projects would be discounted using annuity interest factor since the cashflows are constant. The annuity interest factor at 11.7% discount rate is 2.4145. Project B has the higher NPV and should be undertaken since the two projects are mutually exclusive. Mutually exclusive projects are projects in which the acceptance of one leads to the rejection of the other.

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