Projects A and B are mutually exclusive. Project A costs $20,000 and is expected to generate cash inflows of $7,500 for 4 years. Project B costs $10,000 and is expected to generate a single cash flow in year 4 of $20,000. The cost of capital is 12%. Which project would you accept and why?
A) Project B because it has the higher NPV
B) Project B because it has the higher IRR
C) Project A because it has the higher NPV
D) Project A because it has the higher IRR

Question

Quizplus · Accepted Answer

Project A has the higher NPV, which is the primary criterion for selecting between mutually exclusive projects. The NPV of Project A can be calculated using the formula for NPV = $\sum \frac{C_t}{(1+r)^t} - C_0$, where $C_t$ is the cash inflow at time $t$, $r$ is the discount rate (cost of capital), and $C_0$ is the initial investment. For Project A, the NPV is positive and higher than that of Project B when calculated at a 12% discount rate, making it the preferable choice. Project B's single future cash inflow does not accumulate enough value when discounted back to the present to outweigh the benefits of Project A's multiple cash inflows over time.

Projects a and B Are Mutually Exclusive