Ace Inc. is evaluating two mutually exclusive projects-Project A and Project B. The initial investment for each project is $50,000. Project A will generate cash inflows equal to $15,625 at the end of each of the next five years; Project B will generate only one cash inflow in the amount of $99,500 at the end of the fifth year (i. e., no cash flows are generated in the first four years). The required rate of return of Ace Inc. is 10 percent. Which project should Ace Inc. purchase?

Question

Business

Charlotte Barnes

2 July, 05:53

Ace Inc. is evaluating two mutually exclusive projects-Project A and Project B. The initial investment for each project is $50,000. Project A will generate cash inflows equal to $15,625 at the end of each of the next five years; Project B will generate only one cash inflow in the amount of $99,500 at the end of the fifth year (i. e., no cash flows are generated in the first four years). The required rate of return of Ace Inc. is 10 percent. Which project should Ace Inc. purchase?

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Sammy Lee · Answer 1

Instructions are listed below.

Explanation:

Giving the following information:

The initial investment for each project is $50,000. Project A will generate cash inflows equal to $15,625 at the end of each of the next five years; Project B will generate only one cash inflow in the amount of $99,500 at the end of the fifth year (i. e., no cash flows are generated in the first four years). The required rate of return of Ace Inc. is 10 percent.

To determine which project to choose we need to use the following formula:

NPV = - Io + ∑[Cf / (1+i) ^n]

Cf = cash flow

Project A:

Io = - 50,000

Year 1to 5 = 15,625

NPV = $9,231.04

Project B:

Io = 50,000

Year 5 = 99,500

NPV = - 50,000 + 99,500/1.10^5 = 11,781.67

The highest NPV is the best option. Therefore, project B is the best.