A company that annually reviews its investment opportunities and selects appropriate capital expenditures for the coming year is presented with two projects, called Project A and Project B. Best estimates indicate that the investment outlay for Project A is $30,000 and for Project B is $1 million. The projects are considered to be equally risky. Project A is expected to generate cash inflows of $40,000 at the end of each year for two years. Project B is expected to generate cash inflows of $700,000 at the end of the first year and $500,000 at the end of the second year. The company has a cost of capital of 8%. What is the net present value (NPV) of each project when the cost of capital is zero?
When the cost of capital is zero, the NPV is simply the sum of a project's undiscounted cash flows:
NPV = Cash inflows - Initial outlay
NPV for A = $ 40,000 + $ 40,000 - $ 30,000 = $50,000
NPV for B = $700,000 + $500,000 - $1,000,000 = $200,000