Answer: Project B should be chosen as it has a higher NPV of $70,314.97
Explanation:
You need to find the Net Present Value of both projects. The better investment is the one with a higher Net Present Value.
As there will be inflation, this needs to be included in the required return:
= 10% + 3%
= 13%
This will be the rate for discounting.
Project A:
Net Present Value = Present value of cash inflows - Cash invested
Present value of cash inflows:
This is a constant inflow so is an annuity. Present value will be:
= Amount * Present value interest factor of annuity, 5 years, 13%
= 150,000 * 3.5172
= $527,580
Net Present value = 527,580 - 500,000
= $27,580
Project B:
Net Present Value = Present value of cash inflows - Cash invested
= 50,000 / (1 + 13%)² + 200,000 / 1.13³ + 300,000 / 1.13⁴ + 200,000 / 1.13⁵ - 400,000
= 470,314.97 - 400,000
= $70,314.97
Project B should be chosen as it has higher NPV.
