CFA Practice Question

CFA Practice Question

Beaumont Bearings is analyzing two mutually exclusive projects with the following cash flows. Its cost of capital is 9%.

Which project(s) should Beaumont choose?
A. Project X
B. Project Y
C. Both
Explanation: When choosing among mutually exclusive projects, a company should go with the NPV criterion. In this case, project X has a higher NPV (6,320) than project Y (5,648). The IRR method should not be relied upon for such projects.

NPVX = -10,000 + 8,000/(1.09)1 + 7,000/(1.09)2 + 4,000/(1.09)3 = 6,320
NPVY = -5,000 + 3,000/(1.09)1 + 2,500/(1.09)2 + 7,500/(1.09)3 = 5,648

User Contributed Comments 7

User Comment
smillis Why not both projects? They are both NPV positive and there is no constraint on dollars spent?
angy557 smillis, mutually exclusive means they can only choose one project. X has higher NPV
mc01 these calculations are not hard so the only way to get us to make a mistake is by expecting us not to properly read these questions.
makatang damn it! missed the mutually exclusive :(
harpalani Another way of looking at it: I would choose project X because it returns higher cash flows in earlier years as compared to project Y. Project Y returns higher cash flows in only in later years.
MaresaJaden Harpalani, I don't think you would necessarily know that X as the answer due to the initial cash outlay of project X being double that of Project Y.
ecapocas You can eyeball this. Note WACC is relatively high, and X has both a greater scale AND cash flow returns are front loaded.
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