Answer:
Explanation:
Given that :
Project A will produce annual cash flows of $42,000 at the beginning of each year for eight years.
Project B will produce cash flows of $48,000 at the end of each year for seven years.
Return rate = 12% = 0.12
a) Which project should the company select and why?
To determine the project which the company should select; let find the PV of cash flow:
For project A; PV of cash flows at the beginning of the each year is determined with the use of the expression:
[tex]PV = \frac{PMT}{i} [1-(1+i)^{-n}](1+i)[/tex]
[tex]PV = \frac{PMT}{0.12} [1-(1+0.12)^{-8}](1+0.12)[/tex]
[tex]PV = \frac{42000}{0.12} [1-(1.12)^{-8}](1.12)[/tex]
PV = $233,677.77
For project B , the PV of cash flows at the end of the each year is determined with the use of the expression:
[tex]PV = \frac{PMT}{i} [1-(1+i)^{-n}][/tex]
[tex]PV = \frac{48000}{0.12} [1-(1+0.12)^{-7}][/tex]
[tex]PV = \frac{48000}{0.12} [1-(1.12)^{-7}][/tex]
PV = $219,060.31
Hence, the company should select project A due to the fact that the cashflow is higher.
b) Which project should the company select if the interest rate is 14% at the cash flows in Project B is also at the beginning of each year?
Given that : the new interest rate = 14%;
then :
PV of cahflow for project A is:
[tex]PV = \frac{42000}{0.14} [1-(1.14)^{-8}](1.14)[/tex]
PV = $222,108.80
PV cashflow for project B is:
[tex]PV = \frac{48000}{0.14} [1-(1.14)^{-7}](1.14)[/tex]
PV = $ 234656.04
Here, PV of Cash flow is greater in project B, As such it is best for the company to select Project B
