Homework SourseYour firm is considering the following mutually exclusive pr
Your firm is considering the following mutually exclusive projects:
-$3,300,000
850,000
The firm uses a discount rate of 12.628%. At that discount rate we find that
A-Project A is clearly preferred
B-Project B is clearly preferred
C-the projects have roughly the same NPV\'s
Given that finding, the firm should select ___________because it\'s NPV is the least sensitive to change
A-Project A
B-Project B
| Year | Project A | Project B |
| 0 | -$3,300,000 | -$3,300,000 |
| 1 | 1,940,000 | 866,000 |
| 2 | 1,350,000 | 1,250,000 |
| 3 | 850,000 | 2,325,000 |
Solution
1.
Correct option > C-the projects have roughly the same NPV\'s
2.
Correct option is > A-Project A
Given that finding, the firm should select Project A because it\'s NPV is the least sensitive to change
.
Reason: The major cash flow for Project A falls in 1st and 2nd years hence it is least sensitive to change. The Project B has largest cash flow in year 3 hence it is sensitive to interest rate change.
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NPV Working:
Project A
Discount rate = WACC = R = 12.628%
Present Values
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$3,300,000.00
1.000000
-$3,300,000.00
1
$1,940,000.00
0.887879
$1,722,484.64
2
$1,350,000.00
0.788329
$1,064,243.54
3
$850,000.00
0.699940
$594,949.10
Net Present Value = Total of Present Values =
$81,677.28
Project B
Discount rate = WACC = R = 12.628%
Present Values
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$3,300,000.00
1.000000
-$3,300,000.00
1
$866,000.00
0.887879
$768,902.94
2
$1,250,000.00
0.788329
$985,410.69
3
$2,325,000.00
0.699940
$1,627,360.76
Net Present Value = Total of Present Values =
$81,674.39
| Discount rate = WACC = R = 12.628% | Present Values | ||
| Year | Cash flows | Discount factor or PV factors = Df = 1/(1+R)^Year | PV of cash flows = Cash flows x Df |
| 0 | -$3,300,000.00 | 1.000000 | -$3,300,000.00 |
| 1 | $1,940,000.00 | 0.887879 | $1,722,484.64 |
| 2 | $1,350,000.00 | 0.788329 | $1,064,243.54 |
| 3 | $850,000.00 | 0.699940 | $594,949.10 |
| Net Present Value = Total of Present Values = | $81,677.28 |
