Practice Question
Given the following:
Project A: CF0 = -$12,720; CF1 = $5,650; CF2 = $8,150; CF3 = $14,750
Project B: CF0 = -$15,070; CF1 = $3,930; CF2 = $5,270; CF3 = $14,320; CF4 = $12,331
Project A and Project B are mutually exclusive. The appropriate discount rate k = 12%. Which project should the firm invest?
A) Select Project A because Project A's EANPV is greater than Project B's EANPV.
B) Select Project A because Project A's investment term is shorter than Project B's investment term.
C) Select Project A because Project A's NPV is greater than Project B's NPV.
D) Select Project B because Project B's NPV is greater than Project A's NPV.
E) Select Project B because Project B's EANPV is greater than Project A's EANPV.
Step 1: Calculate NPV for Project A
\[ \text{NPV}_A = \frac{5650}{1.12} + \frac{8150}{1.12^2} + \frac{14750}{1.12^3} - 12720 \] \[ = 5044.64 + 6496.48 + 10502.15 - 12720 = 9323.27 \]
Step 2: Calculate NPV for Project B
\[ \text{NPV}_B = \frac{3930}{1.12} + \frac{5270}{1.12^2} + \frac{14320}{1.12^3} + \frac{12331}{1.12^4} - 15070 \] \[ = 3508.93 + 4201.91 + 10195.05 + 7838.67 - 15070 = 10674.56 \]
Step 3: Compare NPVs
\( \text{NPV}_A = 9323.27 \), \( \text{NPV}_B = 10674.56 \)
Conclusion: Since Project B has a higher NPV than Project A, the firm should invest in Project B.
Final Answer: D) Select Project B because Project B's NPV is greater than Project A's NPV.