Question

A company has three independent investment opportunities. Each investment costs $1,000, and the firm's cost of...

A company has three independent investment opportunities. Each investment costs $1,000, and the firm's cost of capital is 10%. The cash inflow of each investment is as follows:

                 cash inflow   A          B          C

             year

                1               $300       500       100

                2                 300       400       200

                3                 300       200       400

                4                 300       100       500

If the company uses net present value method to evaluate its investments, which investment(s) should the firm make?

investment opportunity C

neither investment opportunity A, B or C

investment opportunity B

investment opportunity A

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Answer #1

Project A:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -1000 + 300 / (1 + 0.1)1 + 300 / (1 + 0.1)2 + 300 / (1 + 0.1)3 + 300 / (1 + 0.1)4

NPV = -$49.04

Project B:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -1000 + 500 / (1 + 0.1)1 + 400 / (1 + 0.1)2 + 200 / (1 + 0.1)3 + 100 / (1 + 0.1)4

NPV = $3.69

Project C:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -1000 + 100 / (1 + 0.1)1 + 200 / (1 + 0.1)2 + 400 / (1 + 0.1)3 + 500 / (1 + 0.1)4

NPV = -$101.77

Projects having positive NPV should be accepted

investment opportunity B

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