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? What if the discount rate is 13.5 percent?

Question

Aubrie Savage

Business

28 August, 01:33

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? What if the discount rate is 13.5 percent?

+2

Answers (1)

Know the Answer?

Wrigley · Answer 1

Project 1 mus be accepted.

Explanation:

Project 1

The present value of the project can be calculated by calculating the present value of the cash inflow which can be found using the discounting formula which is as under:

Present Value = Future Value / (1 + r) ^n

where r for project 1 is 11.7% and n is number of years

Present value of cash inflow from year 1 to year 3 = $34000 / (1.117) ^1 + $34000 / (1.117) ^2 + $34000 / (1.117) ^3 = $82,085

The Net Present Value of project 1 = Present value of cash inflow + Initial Investment

By putting the value we have:

The Net Present Value of project 1 = $82,085 - $80,000 = $2,085

Project 2

The present value of the project 2 will be calculated by simply putting the value in the discounting formula:

Present Value of the cash inflow = $114,000 / (1 + 13.5%) ^3 = $77,968

Net Present Value = $77,968 - $80,000 = ($2,032)

The value is negative which means it is not acceptable and the only project that is positive and hence acceptable is project 1.