Consolidated Inc. uses a weighted average cost of capital of 12% to evaluate average-risk projects and...

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Finance

Consolidated Inc. uses a weighted average cost of capital of 12%to evaluate average-risk projects and adds/subtracts two percentagepoints to evaluate projects of greater/lesser risk. Currently, twomutually exclusive projects are under consideration. Both have acost of $200,000 and last four years. Project A, which is riskierthan average, will produce annual after-tax cash flows of $71,000.Project B, which has less-than-average risk, will produce after-taxcash flows of $146,000 in Years 3 and 4 only. What shouldConsolidated do?
a. Accept neither project since both NPVs are less thanzero.
b. Accept Project A with an NPV of $15,652.
c. Accept both projects since both NPVs are greater thanzero.
d. Accept Project A with an NPV of $6,874.
e. Accept Project B with an NPV of $9,412.

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3.9 Ratings (450 Votes)

First of all we shall calculate the NPV of project A which is riskier than average project by using the below function Initial Investment Present value of Annual after tax cash flows for 4 years at a discount rate of 14 ie 12 2 since we need to add 2 See Answer

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Consolidated Inc. uses a weighted average cost of capital of 12%to evaluate average-risk projects and adds/subtracts two percentagepoints to evaluate projects of greater/lesser risk. Currently, twomutually exclusive projects are under consideration. Both have acost of $200,000 and last four years. Project A, which is riskierthan average, will produce annual after-tax cash flows of $71,000.Project B, which has less-than-average risk, will produce after-taxcash flows of $146,000 in Years 3 and 4 only. What shouldConsolidated do?a. Accept neither project since both NPVs are less thanzero.b. Accept Project A with an NPV of $15,652.c. Accept both projects since both NPVs are greater thanzero.d. Accept Project A with an NPV of $6,874.e. Accept Project B with an NPV of $9,412.