Question

An investment opportunity has an initial cost of $1000 today. In the next year, you will get $1050. The discount rate is 10%. What is the net present value of that investment opportunity?

Now, if the discount rate is 5%, what is the net present value of that investment opportunity?

Now, if the discount rate is 4%, what is the net present value of that investment opportunity?

Answer 1

Net present value (NPV) is a method used to determine the current value of all future cash flows generated by a project, including the initial capital investment. It is widely used in capital budgeting to establish which projects are likely to turn the greatest profit.

The formula for NPV varies depending on the number and consistency of future cash flows. If there’s one cash flow from a project that will be paid one year from now, the calculation for the net present value is as follows.

NPV={Cash flow/(1+i)t}​ − initial investment

where:i=Required return or discount rate

t=Number of time periods​

a) discount rate 10%

(1050/1.10) - 1000 = -45.45

b) discount rate 5%

1050/1.05-1000 = 0

C) discount rate 4%

(1050/1.04) - 1000 = 9.615