Question
Project Cash Flow Today (millions) Cash Flow in One Year (millions) A -$10 $20 B $6...
|
Project |
Cash Flow Today (millions) |
Cash Flow in One Year (millions) |
|||
| A | -$10 | $20 | |||
| B | $6 | $4 | |||
| C | $18 | -$12 |
Suppose all cash flows are certain and the risk-free interest rate is 5%.
a. What is the NPV of each project?
b. If the firm can choose only one of these projects, which should it choose?
c. If the firm can choose any two of these projects, which should it choose?
Homework Answers
Answer #1
| PROJECT |
INITIAL OUTLAY
(IN MILLION DOLLARS) |
CASH FLOW AFTER 1 YEAR
(IN MILLION DOLLARS) |
PRESENT VALUE OF CASH FLOWS
N= NUMBER OF YEARS (IN MILLION DOLLARS) |
NPV
|
|---|---|---|---|---|
| A | -10 | 20 | 19.05 | 29.05 |
| B | 6 | 4 | 3.80 | -2.2 |
| C | 18 | -12 | -11.05 | -29.05 |
R=
RISK FREE RETURN
a.
NPV of Project A=29.05
NPV of Project B=-2.2
NPV of Project C=-29.05
b.
If the firm has to choose only one of these projects it should be Project A because it has the highest NPV.
c.
If the firm has to choose any two of these projects it may do so on the basis of their NPV. Only projects with a posiive NPV must be selected and projects with negative NPV must be rejected. In the given scenario, only Project A has a positive NPV whereas both both Project B and Project C have a negative NPV.Hence only Project A can be selected and the firm should not choose two projects.
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