Project A has an initial cost of $80,000 and provides cash inflows of $34,000 a year for three years. Project B has an initial cost of $80,000 and produces a cash inflow of $114,000 in year 3. The projects are mutually exclusive. Which project(s) should you accept if the discount rate is 11.7 percent? What if the discount rate is 13.5 percent?

Project 1 mus be accepted.

Explanation:

Project 1

The present value of the project can be calculated by calculating the present value of the cash inflow which can be found using the discounting formula which is as under:

Present Value = Future Value / (1 + r)^n

where r for project 1 is 11.7% and n is number of years

Present value of cash inflow from year 1 to year 3 = $34000 / (1.117)^1 + $34000 / (1.117)^2 + $34000 / (1.117)^3 = $82,085

The Net Present Value of project 1 = Present value of cash inflow + Initial Investment

By putting the value we have:

The Net Present Value of project 1  = $82,085 - $80,000 = $2,085

Project 2

The present value of the project 2 will be calculated by simply putting the value in the discounting formula:

Present Value of the cash inflow = $114,000 / (1 + 13.5%)^3 = $77,968

Net Present Value = $77,968 - $80,000 = ($2,032)

The value is negative which means it is not acceptable and the only project that is positive and hence acceptable is project 1.

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