The cost of capital for a firm is 10%. The firm has two possible investments wit
ID: 2629834 • Letter: T
Question
The cost of capital for a firm is 10%. The firm has two possible investments with the following cash inflows:
YEAR A B
1 $300 $200
2 $200 $200
3 $100 $200
A,) Each investment costs $480. What investment(s) should the firm make according to net present value?
B.) What is the internal rate of return for the two investments? Which investment(s) should the firm make? Is this the same answer you obtained in part A
C.) If the cost of capital rises to 14%, which investment(s) should the firm make?
Please be detailed and show and explain all work. Thank you so much:-)
Explanation / Answer
(A)
Therefore, on basis of NPV, Project A must be chosen.
(B)
At IRR,
Present value of cash outflows = Present value of cash inflows
Project A:
480 = 300 / (1+r) + 200 / (1+r)2 + 100 / (1+r)3
Let r = 14%
R.H.S. = 300 / (1+0.14) + 200 / (1+0.14)2 + 100 / (1+0.14)3
= 484.55 = 480 (appro, variation of 1% is allowed)
Therefore, IRR for Project A is 14%.
Project B:
480 = 200 / (1+r) + 200 / (1+r)2 + 200 / (1+r)3
Let r = 13.5%
R.H.S. = 200 / (1+0.135) + 200 / (1+0.135)2 + 200 / (1+0.135)3
= 476.27 = 480 (appro, variation of 1% is allowed)
Therefore, IRR for Project B is 13.5%.
Therefore, on basis of NPV, Project B must be chosen. Yes, the answer is same as that of Part A.
(C)
Cost of capital = 14%
Years (a) Cash Flows from Project A (b) Cash Flows from Project B (c) Discounting factor @ 10% (d) Present value of cash flows from Project A (e=bxd) Present value of cash flows from Project B (f =cxd) 1 300 200 0.91 272.73 181.82 2 200 200 0.83 165.29 165.29 3 100 200 0.75 75.13 150.26 Total Inflows 513.15 497.37 Initial Investments 480.00 480.00 NPV 33.15 17.37Related Questions
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