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A company has to make a choice between two projects, because the available resources in money and kind are not sufficient to run both at the same time. Each project would take 9 months and would cost $250,000.The first project is a process optimization, which would result in a cost reduction of $120,000 per year. This benefit would be achieved immediately after the end of the project. The second project would be the development of a new product, which could produce the following net profits after the end of the project: 1st year: $ 15,000 2nd year: $ 125,000 3rd year: $ 220,000 Assumed is a discount rate of 5 % per year. Looking at the net present values of these projects' revenues in the first 3 years, what is true?
Correct Answer: A
As, PV = FV/(1+r)^n. Since both projects will take same amount of time and money to develop, for purposes of comparison we can ignore the development cycle. Present Value for 1st project, PV1 = 120/1.05 + 120/1.05^2 + 120/1.05^3 = 114.286 + 108.844 + 103.661 = 326.790.Present Value for 2nd project, PV2 = 15/1.05 + 125/1.05^2 + 220/1.05^3 = 14.286 +113.379 + 190.044 = 317.709.