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 \$500 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 3% 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 11%, 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 @ 11% PV A B C = A x B 1 550.00 0.9009 495 2 566.50 0.8116 460 3 583.50 0.7312 427 4 601.00 0.6587 396 5 619.03 0.5935 367 6 637.60 0.5346 341 7 656.73 0.4817 316 8 676.43 0.4339 294 9 696.72 0.3909 272 Sum of PV of cash inflow 3368 Less: Initial Investment 2250 NPV 1118

Thus NPV of project B = 1118\$

Since NPV of project B is more than project A, Project B should be selected

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