Question

Your company is considering an investment in one of two mutually exclusive projects. Project one involves a labor-intensive production process. Initial outlay for Project 1 is $1,495 with expected after tax cash flows of $500 per year in years 1-5. Project two involves a capital intensive process, requiring an initial outlay of $6,704. After tax cash flows for Project 2 are expected to be $2,000 per year for years 1-5. Your firm's discount rate is 10%. If your company is not subject to capital rationing, which project(s) should you take on?

Select one:

a. Project 2

b. Projects 1 and 2

c. Neither project is acceptable

d. Project 1

Answer 1

Project 1 and 2

Step-by-step explanation:

To determine which project to take on, the Net Present value is calculated using the financial calculator

For project 1 ,

Cash flow for year 0 = $-1495

Cash flow from year 1 - 5 = $500

Discount rate = 10%

NPv = $400.39

For project 2,

Cash flow for year 0 = $-6704

Cash flow from year 1 - 5 = $2,000

Discount rate = 10%

NPV = $877.57

Project 1 and 2 should be undertaken since they both have positive NPVs and there's no capital rationing.