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15 March, 08:34

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?

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  1. 15 March, 09:33
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    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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