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11 June, 11:31

Projects A and B are mutually exclusive and have an initial cost of $82,000 each. Project A provides cash inflows of $34,000 a year for three years while Project B produces a cash inflow of $115,000 in Year 3. Which project (s) should be accepted if the discount rate is 11.7 percent? What if the discount rate is 13.5 percent?

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  1. 11 June, 11:57
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    If discount rate is 11.7% Project B should be accepted.

    If discount rate is 13.5% both projects should be rejected

    Explanation:

    If the Net present value of Project A is higher than that of project B, we will accept project A and vice versa.

    Under 11.7% Discount Rate

    Net Present Value-Project A = - 82000 + 34000 / 1.117 + 34000 / 1.117² + 34000 / 1.117³ = $85.099

    Net Present Value-Project B = - 82000 + 115000 / 1.117³ = $516.029

    Project B should be accepted as it has a higher NPV.

    Under 13.5% Discount Rate

    Net present Value-Project A = - 82000 + 34000 / 1.135 + 34000 / 1.135² + 34000 / 1.135³ = - $2397.49

    Net Present Value-Project B = - 82000 + 115000 / 1.135³ = - $3347.91

    Both projects should be rejected as both have negative NPVs
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