Question

For each of the following six investment choices, compute the net present value. Determine which investment should be accepted or rejected according to the net present value criterion

A contract is estimated to yield net returns of $3500 quarterly for seven years. To secure the contract, an immediate outlay of $50 000 and a further outlay of $30 000 three years from now are required. Interest is 12% compounded quarterly.

Answer 1

quarterly rate r=12%/4=3%

CF0=-50000
CF1, CF2, CF3, CF4, CF5, CF6, ....CF28=3500
CF12=-30000

Present value of outflows=CF0+CF12/(1+r)^(4*3)=-50000-30000/(1+3%)^12=-71041.40

Present value of inflows=Present value of ordinary annuity=Quarterly cash flows/quarterly rate*(1-1/(1+quarterly rate)^n-1)=3500/(12%/4)*(1-1/(1+12%/4)^(4*7))=65674.38

NPV=Present value of outflows+Present value of inflows=-71041.40+65674.38=-5367.01761

As NPV is negative, do not accept i.e., reject the project