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If the WACC were 5% and A and B were mutually exclusive, which would you choose? Your division...

Question:

If the WACC were 5% and A and B were mutually exclusive, which would you choose?

Your division is considering two projects with the following cash flows (in millions):

0 1 2 3
Project A -$27 $13 $17 &8
Project B -$25 $14 $11 $2

Mutually Exclusive Projects:

Mutually exclusive projects are projects that cannot be undertaken together. This means that if one project is accepted, the other project will be rejected. The reason behind the exclusion is that the projects are said to compete for similar resources.

Answer and Explanation:

The net present value will be used to evaluate the projects:

  • {eq}\text{Net present value= Present value of cash flows - Initial cost of investment} {/eq}

Projet A:

  • {eq}\text{Net present value}= [ $13\times (1+0.05)^{-1}+$17\times (1+0.05)^{-2}+$8\times (1+0.05)^{-3} ]-$27 {/eq}
  • {eq}\text{Net present value}= $7.71\text{Million} {/eq}

Projet B:

  • {eq}\text{Net present value}= [ $14\times (1+0.05)^{-1}+$11\times (1+0.05)^{-2}+$2\times (1+0.05)^{-3} ]-$25 {/eq}
  • {eq}\text{Net present value}= $0.038\text{Million} {/eq}

Based on the above analysis both projects have positive net present value therefore, The project with the highest NPV should be accepted. Therefore accept project A.


Learn more about this topic:

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Mutually Exclusive in Statistics: Definition, Formula & Examples

from High School Algebra II: Help and Review

Chapter 25 / Lesson 8
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