Answer:
The net present value of project B is higher than Project A, so Project B should be accepted.
Step-by-step explanation:
In this question, we have to use the net present value formula which is shown below:
Net present value = Present value of all years cash flows - Initial investment
where,
Present value of cash inflows is calculated by applying the discount rate which is presented below:
For this, we have to first compute the present value factor which is computed by a formula
= 1 ÷ (1 +rate) ∧ number of year
number of year = 0
number of year = 1
Number of year = 2
number of year = 3
So,
Rate = 11.25%
For year 1 = 0.8989 (1 ÷ 1.1125) ∧ 1
For year 2 = 0.8080 (1 ÷ 1.1125) ∧ 2
For year 3 = 0.7263 (1 ÷ 1.1125) ∧ 3
Now, multiply this present value factor with yearly cash inflows
So
For Project A,
The present value of year 1 = $11,400 × 0.8989 = $10,247.191
The present value of year 2 = $16,900 × 0.8080 = $13,654.842
The present value of year 3 = $26,200 × 0.7263 = $19028.354
and the sum of all year cash inflow is $42,930.387
So, the Net present value would be equal to
= $42,930.387 - $38,900 = $4,030.387
And,
For Project B
Rate = 11.85%
For year 1 = 0.8941(1 ÷ 1.1185) ∧ 1
For year 2 = 0.7993 (1 ÷ 1.1185) ∧ 2
For year 3 = 0.7146 (1 ÷ 1.1185) ∧ 3
Now, multiply this present value factor with yearly cash inflows
So
For Project B,
The present value of year 1 = $20,000 × 0.8941 = $17,881.091
The present value of year 2 = $20,000 × 0.7993 = $15,986.670
The present value of year 3 = $20,000 × 0.7146 = $14,292.955
and the sum of all year cash inflow is $48,160.716
So, the Net present value would be equal to
= $48,160.716 - $41,300 = 6,860.716
Since the net present value of project B is higher than Project A, so Project B should be accepted.