Your company is considering an investment in one of two mutually exclusive projects.Project one 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 two 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

In order to determine which project to choose, we need to calculate the present value of each project's cash flows.

For Project 1:

PV = $500 / (1 + 0.1)^1 + $500 / (1 + 0.1)^2 + $500 / (1 + 0.1)^3 + $500 / (1 + 0.1)^4 + $500 / (1 + 0.1)^5 
PV = $1,854.91

For Project 2:

PV = $2,000 / (1 + 0.1)^1 + $2,000 / (1 + 0.1)^2 + $2,000 / (1 + 0.1)^3 + $2,000 / (1 + 0.1)^4 + $2,000 / (1 + 0.1)^5 
PV = $7,447.62

Since Project 2 has a higher present value, it should be chosen over Project 1. Therefore, the best choice is B - Project 2.

Your Company Is Considering an Investment in One of Two