Question

Cash flows of two mutually exclusive projects are as follows. Project A costs $80,000 initially and will have a $15,000 salvage value after 3 years. The operating cost with this method will be $30,000 per year. Project B has initial cost of $120,000, an operating cost of $8,000 per year, and a $40,000 salvage value after its 3-year life. Assume the interest rate is 10% per year. Which of the following statements is true?

A. Two projects have different life cycle
B. Project A should be selected.
C. The present worth of project A is -$143,252.17.
D. The present worth of project B is -$109,842.22.

Answer 1

The correct answer is B.

Step-by-step explanation:

Giving the following information:

Project A:

Costs $80,000 initially and will have a $15,000 salvage value after 3 years. The operating cost with this method will be $30,000 per year.

Project B:

The initial cost of $120,000, an operating cost of $8,000 per year, and a $40,000 salvage value after its 3-year life.

Assume the interest rate is 10% per year.

Both projects present a 3-year life cycle.

To determine which option is correct, we need to calculate the net present value using the following formula:

NPV= -Io + ∑[Cf/(1+i)^n]

Cf= cash flow

Project A:

Cf1= 30,000/1.10= 27,272.73

Cf2= 30,000/1.10^2= 24,793.39

Cf3= 45,000/1.10^3= 33,809.17

Total= 85,875.29

NPV= -80,000 + 85,875.29= 5,875.29

Because the net present value is positive, Project A should be accepted.

Project B doesn't provide income, therefore it shouldn't be accepted.