Project X has an up-front cost of $1 million, whereas Project Y has an up-front cost of only $200,000. Both projects last five years and provide positive cash flows in Years 1-5. Project X is riskier; its risk-adjusted WACC is 12 percent. Project Y is safer; its risk-adjusted WACC is 8 percent. After discounting each of the project's cash flows at the project's risk-adjusted WACC, you find that Project X has a NPV of $20,000, and Project Y has a NPV of $15,000. The projects are mutually exclusive and cannot be repeated. The firm is not capital constrained; it can raise as much capital as it needs, provided it has profitable projects in which to invest. Given this information, which of the following statements is most correct?
A) The firm should select Project Y because it has a higher return; ($15,000/$200,000) is greater than ($20,000/$1,000,000).
B) The firm should select Project X because it has a higher NPV.
C) The firm should select Project Y because it is less risky.
D) The firm should reject both projects because their IRRs are less than the risk-adjusted WACC.
E) Statements a and c are correct.
Medium

Question

Quizplus · Accepted Answer

When considering mutually exclusive projects, the project with the higher NPV should be selected. In this case, Project X has a higher NPV of $20,000 compared to Project Y's NPV of $15,000. Therefore, the firm should select Project X. The return on investment (ROI) is not a relevant factor when choosing between mutually exclusive projects, as the absolute dollar amount of the NPV is what matters. The risk level of the projects is also not a decisive factor in this case, as both projects have positive NPVs and the firm is not capital constrained. The IRR is also not relevant when choosing between mutually exclusive projects.

Project X Has an Up-Front Cost of $1 Million, Whereas