Two mutually exclusive projects, expected to last indefinitely, are being compared. Program A has annual profits and consumer surplus of $10 million and a one-time capital expenditure of $50 million. Program B has consumer surplus of $15 million and a one-time capital expenditure of $100 million. Using net present value as a criterion, which alternative should be selected?

Question

Quizplus · Accepted Answer

To determine the correct choice, we calculate the Net Present Value (NPV) for both programs at different discount rates. NPV is calculated as the present value of cash inflows minus the present value of cash outflows. For an indefinite duration, the formula simplifies to (Annual Profit / Discount Rate) - Initial Investment. For Program A at any discount rate, NPV = ($10M / Discount Rate) - $50M. For Program B, NPV = ($15M / Discount Rate) - $100M. At a discount rate less than 10%, Program B's NPV becomes higher than Program A's, making it the preferred choice. At a 22% discount rate, both programs would have negative NPVs, making neither a viable option.

Two Mutually Exclusive Projects, Expected to Last Indefinitely, Are Being