Carlyle Inc. is considering two mutually exclusive projects. Both require an initial investment of $15,000 at t = 0. Project S has an expected life of 2 years with after-tax cash inflows of $7,000 and $12,000 at the end of Years 1 and 2, respectively. Project L has an expected life of 4 years with after-tax cash inflows of $5,200 at the end of each of the next 4 years. Each project has a WACC of 9.00%, and neither can be repeated. The controller prefers Project S, but the CFO prefers Project L. How much value will the firm gain or lose if Project L is selected over Project S, i.e., what is the value of NPVL - NPVS?
A) $262.74
B) $291.93
C) $324.37
D) $356.80
E) $392.48

Question

Quizplus · Accepted Answer

We need to find the net present value (NPV) of both projects and then find the difference to determine the value gained or lost by selecting Project L over Project S.

For Project S:

Year 1 cash inflow = $7,000 
Year 2 cash inflow = $12,000

NPVS = - $15,000 + ($7,000 / 1.09) + ($12,000 / 1.09^2) 
NPVS = $3,560.80

For Project L:

Year 1-4 cash inflows = $5,200

NPVL = - $15,000 + ($5,200 / 1.09) + ($5,200 / 1.09^2) + ($5,200 / 1.09^3) + ($5,200 / 1.09^4) 
NPVL = $3,235.43

The value of NPVL - NPVS is:

$3,235.43 - $3,560.80 = -$325.37

This means that the company would lose $325.37 in value by selecting Project L over Project S. Therefore, the best choice is Project S.