Sun Systems Company has two investment opportunities. Both investments cost $7,0

Question

Sun Systems Company has two investment opportunities. Both investments cost $7,000 and will provide the same total future cash inflows. Sun Systems has a required (desired) rate of return of 6%. The cash receipts schedule for each investment is given below:

All other things being equal,

a. investment alternative 1 will produce a higher net present value than alternative 2.

b. investment alternative 2 will produce a higher net present value than alternative 1.

c. both investment opportunities will produce the same net present value.

d. The answer cannot be determined from the information provided.

Investment 1 Investment 2   Period 1 $ 2,000 $ 2,000   Period 2 2,000 3,000   Period 3 2,000 4,000   Period 4 5,000 2,000

All other things being equal,

a. investment alternative 1 will produce a higher net present value than alternative 2.

b. investment alternative 2 will produce a higher net present value than alternative 1.

c. both investment opportunities will produce the same net present value.

d. The answer cannot be determined from the information provided.

Explanation / Answer

Calculation of NPV:

NPV = PV of Inflow - Outflow

For Investment 1 = 9,306.50 - 7,000 = $2,306.50

For Investment 2 = 9,499.40 - 7,000 = $2,499.40

So, the correct option is B.

b. investment alternative 2 will produce a higher net present value than alternative 1.

Period DF(6%) Investment 1 PV Investment 2 PV 1 0.9434 2,000 1,886.80 2,000 1,886.80 2 0.8900 2,000 1,780 3,000 2,670 3 0.8396 2,000 1,679.20 4,000 3,358.40 4 0.7921 5,000 3,960.50 2,000 1,584.20 Total 9,306.50 9,499.40

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