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 $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?

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 @ 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