Capital Budgeting Project Evaluation: Project X vs. Project Z

Project Comparison: Net Cash Flows, Cost of Capital, and Selection

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Question

As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

YearProject XProject Z -

0-$100,000-$100,000

150,000 10,000

240,000 30,000

330,000 40,000

410,000 60,000

If Denver's cost of capital is 15 percent, which project would you choose?

Answers

A. Project Z, since it has the higher NPV.

B. Project X, since it has the higher NPV.

C. Neither project.

D. Project X, since it has the higher IRR.

E. Project Z, since it has the higher IRR. C

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Explanations

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A. B. C. D. E.

Explanation

(In thousands)

NPV(X) = -100 + 50(PVIF(15%,1)) + 40(PVIF(15%,2)) + 30(PVIF(15%,3)) + 10(PVIF(15%,4)) = -100 + 50(0.8696) + 40(0.7561) + 30(0.6575) + 10(0.5718) = -

0.833 = -$833.

NPVZ = -100 + 10(PVIF(15%,1)) + 30(PVIF(15%,2)) + 40(PVIF(15%,3)) + 60(PVIF(15%,4)) = -100 + 10(0.8696) + 30(0.7561) + 40(0.6575) + 60(0.5718) = -8.013

= -$8,013.

At a cost of capital of 15%, both projects have negative NPVs and, thus, both would be rejected.

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