Question

You are installing a solar panel today on the roof of your house and it costs 4000. Over the next 12 months the expected savings from this investment can be either 300 or 100 with equal probability. For simplicity you can assume that those savings will be realized in perpetuity. The opportunity cost of capital is 5%. Is this a good investment today? What about if you wait for a year? Discuss. how can i find the IRR of this problem?

Answer 1

Answer:

Expected saving per year = 300 * 50% + 100*50% = 150 + 50 = 200

Assuming these savings will be realized in perpetuity:

Present value of savings = Perpetual Annual savings / Cost of capital = 200 / 5% = 4,000

Net present value = Present value of savings - Initial investment = 4000 - 4000 = 0

As NPV is zero, you would indifferent to this investment.

If you wait for a year, both investment and savings may increase depending on inflation rate and it is possible that NPV may remain zero and you would remain indifferent.

As at 5% cost of capital, NPV is zero, the IRR of the investment is 5%.