Table 10.4
A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows:
-The new financial analyst does not like the payback approach (Table 10.4) and determines that the firm's required rate of return is 15 percent. His recommendation would be to

Question

Table 10.4
A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows: 
-The new financial analyst does not like the payback approach (Table 10.4) and determines that the firm's required rate of return is 15 percent. His recommendation would be to

Quizplus · Accepted Answer

The new financial analyst determined that the firm's required rate of return is 15 percent, which means that the project's payback period should not be the only factor considered. Using the net present value (NPV) method, we can calculate the present value of the cash flows of each project and see which one has a positive NPV.

Using the formula for NPV, we get:

NPV (Project A) = -10,000 + 4,000/(1+0.15) + 5,000/(1+0.15)^2 + 6,000/(1+0.15)^3 = $2,311.04
NPV (Project B) = -20,000 + 8,000/(1+0.15) + 9,000/(1+0.15)^2 + 10,000/(1+0.15)^3 = $2,802.37

Therefore, project B has a higher NPV than project A, and it should be accepted while project A should be rejected. Thus, the answer is C, reject project A and accept B.

Table 10.4 A Firm Is Evaluating Two Projects That Are Mutually Exclusive