Calculating NPV for Two Potential Projects

Question

Tri-City Industries is considering two possible capital projects. Project A requires an initial investment of $240,000 and provides cash flows before tax of $120,000 in year one, $140,000 in year two, and $160,000 in year three. If project A is accepted, project B may be undertaken. It provides cash flows before tax of $140,000 for each of three years. However, projects A and B are partial substitutes, and the cash flows of project A will decrease by $40,000 in each of the three years if project B is also undertaken. The company’s weighted average cost of capital is 13% and its tax rate is 35%. Ignore the impact of depreciation for this question.

a. What is the NPV of doing only project A?

b. What is the maximum amount that project B can cost so that the combination of taking

both projects provides the same benefit of investing only in project A?

Summary

The question belongs to Finance and it is about the calculation of NPV for two projects A and B. Detailed calculations and explanation have been given in the solution.

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