Question

A firm is evaluating two mutually exclusive projects that have unequal lives. The firm must evaluate the projects using the annualized net present value approach and recommend which project they should select. The firm's cost of capital has been determined to be 14 percent, and the projects have the following initial investments and cash flows:_________.

Project R Project S
Initial investment: $40,000 $58,000
Cash flows: 1 $20,000 $30,000
2 20,000 55,000
3 20,000
4 20,000
A. Choose Project R because its ANPV is $6459
B. Choose Project S because its ANPV is $6459
C. Choose Project S because its ANPV is $10,637
D. Choose Project R because its ANPV is $18,274

Answer 1

B. Choose Project S because its ANPV is $6459

Step-by-step explanation:

The computation is shown below:

Year Discounting factor at 14% Project R PV of project R Project S PV of project S

0 1 -$40,000 -$40,000 -$58,000 -$58,000

1 0.8772 $20,000 $17,544 $30,000 $26,316

2 0.7695 $20,000 $15,389 $55,000 $42,321

3 0.6750 $20,000 $13,499

4 0.5921 $20,000 $11,842

NPV $18,274 $10,636

where discounting factor for year 1 = 1 ÷ 1.14 = 0.8772

So,

ANPV for project R = 18274 ÷ 2.9137 = $6272

ANPV for project S = 10636 ÷ 1.6467 = $6459

The 2.9137 is cumulative discounting factor for 4 years & 1.6467 is cumulative discounting factor for 2 years at 14%