Question

# As an investor you are investigating two different investment opportunities (projects) at time zero. Starting from...

As an investor you are investigating two different investment opportunities (projects) at time zero. Starting from year 1, Project A offers to pay you \$500 every year for 10 years, whereas Project B offers to pay you \$550 for the first year and a yearly increased amount for the next 8 years after year 1. Project B’s payment in year t+1 will be 1% higher than its payment in year t. In year 0, Project A costs \$2200 while Project B costs \$2250. If the discount rate for Project A is 10% and for Project B is 13%, which one of these two investment opportunities would you pick?

Statement showing NPV of project A

 Year Cash flow PVIF @ 10% PV A B C = A x B 1 500 0.9091 455 2 500 0.8264 413 3 500 0.7513 376 4 500 0.6830 342 5 500 0.6209 310 6 500 0.5645 282 7 500 0.5132 257 8 500 0.4665 233 9 500 0.4241 212 10 500 0.3855 193 Sum of PV of cash inflow 3072 Less: Initial Investment 2200 NPV 872

Thus NPV of project A = 872\$

Statement showing NPV of project B

 Year Cash flow PVIF @ 13% PV A B C = A x B 1 550.00 0.8850 487 2 555.50 0.7831 435 3 561.06 0.6931 389 4 566.67 0.6133 348 5 572.33 0.5428 311 6 578.06 0.4803 278 7 583.84 0.4251 248 8 589.67 0.3762 222 9 595.57 0.3329 198 Sum of PV of cash inflow 2915 Less: Initial Investment 2250 NPV 665

Thus NPV of project B = 665\$

Project A should be selected as it has higer NPV