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Project A has a required return on 9.2 percent and cash flows of −$87,000, $32,600, $35,900, and $43,400 for Years 0 to 3, respectively. Project B has a required return of 12.7 percent and cash flows of −$85,000, $14,700, $21,200, and $89,800 for Years 0 to 3, respectively. Which project(s) should you accept based on net present value if the projects are mutually exclusive?

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Answer:

                PROJECT A

Year Cashflow DF@9.2%       PV

            $                                                $

0        (87,000)            1          (87,000)

1              32,600            0.9158              29,855

2  35900  0.8386             30,105

3              43,400            0.7679              33,326

                                                       NPV    6286

                       PROJECT B

Year Cashflow DF@12.7% PV

             $                     $

0           (85,000) 1  (85,000)

1             14,700      0.8873       13,043

2      21.200      0.7873       16,691  

3                  89,800     0.6986       62,734

                                              NPV   7,468

Project B should be accepted because it has the higher NPV

Explanation:

In obtaining the net present value, there is need to discount the cashflow for each year at the required rate of return of each project. The discount factor can be calculated as (1+r)n. Thereafter, the net present value is computed as the difference between the present value of cashflow  and initial outlay.

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