Question

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?

Answer 1

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