NPV Analysis of Projects A, B, and C | CFA Level 1 Exam Prep

NPV Analysis of Projects A, B, and C

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Question

Consider the following three projects:

Project A -

Initial cash outflow: $1,000,000

Cash inflows as follows -

t1: $500,000

t2: $450,000

t3: $150,000

t4: $150,000

t5: $150,000

Project B -

Initial cash outflow: $1,000,000

Cash inflows as follows -

t1: $150,000

t2: $150,000

t3: $150,000

t4: $450,000

t5: $500,000

Project C -

Initial cash outflow $1,000,000 -

Cash inflows as follows -

t1: $280,000

t2: $280,000

t3: $280,000

t4: $280,000

t5: $280,000

Assuming no taxes, an 8.5% cost of capital, along with a $0.00 salvage value at the end of the fifth year, what is the NPV of each project? Additionally, which of the three projects has the steepest NPV profile?

Answers

A. Project A NPV: $276,837; Project B NPV: $40,334; Project C NPV: $103,380; Project A has a steepest NPV profile

B. Project A NPV: $ 267,837; Project B NPV: $44,330, Project C NPV: $135,820; Project A has a steepest NPV profile

C. Project A NPV: $168,513.54 Project B NPV: $40,334; Project C NPV: $103,380; Project B has a steepest NPV profile

D. Project A NPV: $168,531.54; Project B NPV: $40,334; Project C NPV: $103,380; Project C has a steepest NPV profile

E. Project A NPV: $168,513.54, Project B NPV: $14,550; Project C NPV: $103,380; Project B has the steepest NPV profile

F. Project A NPV: $276,837; Project B NPV: $114,550; Project C NPV: $135,820; Project A has a steepest NPV profile

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Explanations

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A. B. C. D. E. F.

Due to the fact that project B is characterized by having the majority of its cash inflows occurring during later time periods, it is more sensitive to changes in the cost of capital. This fact is exemplified by a steeper NPV profile.

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