Suzie owns a computer reselling business and is expanding it. She is presented with two options. Under Proposal A, the estimated investment for the ex... Accounting MCQs | Accounting MCQs

Suzie owns a computer reselling business and is expanding it. She is presented with two options. Under Proposal A, the estimated investment for the expansion project is $85,000, and it is expected to produce after-tax cash flows of $25,000 for each of the next 6 years. Proposal B involves an investment of $32,000 and after-tax cash flows of $10,000 for each of the next 6 years. Between which two desired rates of return will Suzie be indifferent to either proposal?

10% and 12%.
14% and 16%.
16% and 18%.
18% and 20%.Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

Answer (C) is correct. The desired rate of return at which the two projects will produce the same NPV can be found by calculating the IRR of the difference in cash flows between the two projects. Proposal A requires an additional investment of $53,000 and generates extra cash flows of $15,000 for 6 years. Dividing the incremental investment by the annual cash flows yields a result of 3.533 ($53,000 ÷ $15,000). In other words, this
is the present value factor necessary to make the cash flows equal the incremental investment. Consulting the present value table for an ordinary annuity for 6 years reveals that 3.533 is somewhere between 16% and 18%.