Question

A company has the option to invest in project A, project B, or neither (the projects are mutually exclusive and the company has no other investment options). Project A requires an initial investment of $100,000 today and provides cash flows of $35,000 a year for five years. The project will also return back S20,000 in capital in year six. Project B requires a $135,000 investment today and will have cash flows of $40,000 a year for 5 years. The firm's hurdle rate for these projects is 8%. Which project should be selected (since, the projects are mutually exclusive you cannot invest in both for whatever reason so you should choose the one with the highest NPV if the NPV of that project is positive. If both are negative NPV, then follow the NPV rule)?

a) Project A
b) Project B.
с Neither Project A nor Project B

Answer 1

To decide on the investment, calculate the Net Present Value (NPV) for both Project A and Project B using the 8% hurdle rate. The project with the highest positive NPV is the preferred choice; if both have negative NPVs, neither should be chosen.

Step-by-step explanation:

To determine which project the company should invest in, we need to calculate the Net Present Value (NPV) for both Project A and Project B using the firm's hurdle rate of 8%. NPV is the sum of the present values of incoming and outgoing cash flows over a period of time. We will use the NPV formula for each project, discounting future cash flows back to their present value.

For Project A, the NPV calculation is as follows:

• Years 1-5: $35,000 each year
• Year 6: additional $20,000 return

For Project B, the NPV calculation is as follows:

• Years 1-5: $40,000 each year

After calculating the NPV for each project, the one with the highest positive NPV should be selected. If both projects have a negative NPV, then neither project should be selected as per the NPV rule.