Your company is considering an investment in one of two mutually exclusive projects.Project 1 involves a labor intensive production process.Initial outlay for Project 1 is $1,495 with expected after-tax cash flows of $500 per year in years 1-5.Project 2 involves a capital intensive process,requiring an initial outlay of $6,704.After-tax cash flows for Project 2 are expected to be $2,000 per year for years 1-5.Your firm's discount rate is 10%.If your company is not subject to capital rationing,which project(s)should you take on?
A) Project 1
B) Project 2
C) Projects 1 and 2
D) Neither project is acceptable.

Question

Quizplus · Accepted Answer

To compare the profitability of the two projects, we need to calculate the present value of the after-tax cash flows for each project. Using a discount rate of 10%, the present value of the after-tax cash flows for Projects 1 and 2 are:

PV(Project 1) = $500(PVIFA(10%,5)) - $1,495 = $1,736.71
PV(Project 2) = $2,000(PVIFA(10%,5)) - $6,704 = $4,748.81

Since the present value of Project 2's cash flows is higher than that of Project 1's cash flows, and the initial investment is only made once, we should choose to invest in Project 2. Therefore, the best choice is option B.

Your Company Is Considering an Investment in One of Two