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19 June, 18:34

Wilson's Market is considering two mutually exclusive projects that will not be repeated. The required rate of return is 13.9 percent for Project A and 12.5 percent for Project B. Project A has an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $69,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. Which project, or projects, if either, should be accepted and why?

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  1. 19 June, 19:01
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    Project A shall be accepted as Project A has positive and higher NPV than Project B.

    Explanation:

    Since the projects are mutually exclusive we will evaluate the NPV that is Net present value of the projects.

    Project A

    Present Value of Cash outflow = $54,500

    Rate of return = 13.9%

    Present value of cash inflows

    Year Cash flow PV @13.9% Present Value

    1 $16,400 0.878 $14,399.2

    2 $28,900 0.771 $22,281.9

    3 $31,700 0.677 $21,460.9

    Total cash inflow $58,142

    NPV = $58,142 - $54,500 = $3,642

    Project B

    Present Value of Cash outflow = $69,400

    Rate of return = 12.5%

    Present value of cash inflows

    Year Cash flow PV @ 12.5% Present Value

    1 $0 0.888 $0

    2 $48,300 0.790 $38,157

    3 $42,100 0.702 $29,554.2

    Total cash inflow $67,711.2

    NPV = $67,711.2 - $69,400 = - $1,688.8

    Since NPV of Project B is negative and that of project A is positive Project A shall be selected, as there will be loss in case of Project B.
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