PLEASE READ: I already know how to get the correct answer to this question, I am

Question

PLEASE READ: I already know how to get the correct answer to this question, I am just confused on how it works. Why am I not supposed to plug in -1,200,000 as the initial cash flow for choices C and D? As you probably know, it only works when I use 0 in the CF_0 slot on my financial calculator, and it doesn't make sense to me because VERY similar questions require me to plug in the negative initial investment value instead. So can you just explain to me why 0 is used, and how am I supposed to know when to use 0 or the actual initial investment value? Thank you in advance.

A company has identified the following investments as looking promising. Each requires an initial investment of? $1.2 million. Which is the best? investment?

A. a perpetuity that generates a cash flow at the end of year 1 of? $100,000, has a growth rate of? 1.25%, and a cost of capital of 10.710.7?%

B. a perpetuity that generates a cash flow at the end of year 1 of? $800,000, has a growth rate of? 2.25%, and a cost of capital of 1212?%

C. an investment that generates a cash flow of? $400,000 at the end of each of the next five? years, when the cost of capital is 6.56.5?%

D. an investment that generates a cash flow of? $200,000 at the end of each of the next ten? years, when the cost of capital is 6.56.5?%

Explanation / Answer

NPV (A) = -1.2 M + 0.1M/( 10.7% - 1.25%) = -$141,798.94 IV NPV (B) = -1.2 M +0.8M / (12% - 2.25%) = $7,005,128.21 I NPV(C) (calculated below) $462,271.78 II NPV(D) (calculated below) $237,766.04 III Year Cash Flow PV @ 6.5% Present Value 0 -$1,200,000.00 1.0000 -$1,200,000.00 1 $400,000.00 0.9390 $375,586.85 2 $400,000.00 0.8817 $352,663.71 3 $400,000.00 0.8278 $331,139.64 4 $400,000.00 0.7773 $310,929.24 5 $400,000.00 0.7299 $291,952.33 NPV(c) $462,271.78 Press 2nd FV to clear the financial keys. Enter the numbers into the appropriate keys: 5 into N, 6.5 into I/Y, and 400000 (a cash inflow) into PMT. Now press CPT PV to solve for the present value. The answer is -1,662,271.78.This is negative because it represents cash outflow, add initial investment $1,200,000. The NPV is $462,271.78 Year Cash Flow PV @ 6.5% Present Value 0 -$1,200,000.00 1.0000 -$1,200,000.00 1 $200,000.00 0.9390 $187,793.43 2 $200,000.00 0.8817 $176,331.86 3 $200,000.00 0.8278 $165,569.82 4 $200,000.00 0.7773 $155,464.62 5 $200,000.00 0.7299 $145,976.17 6 $200,000.00 0.6853 $137,066.82 7 $200,000.00 0.6435 $128,701.24 8 $200,000.00 0.6042 $120,846.24 9 $200,000.00 0.5674 $113,470.65 10 $200,000.00 0.5327 $106,545.21 NPV(D) $237,766.04 Press 2nd FV to clear the financial keys. Enter the numbers into the appropriate keys: 10 into N, 6.5 into I/Y, and 200000 (a cash inflow) into PMT. Now press CPT PV to solve for the present value. The answer is -1,437,766.04.This is negative because it represents cash outflow, add initial investment $1,200,000. The NPV is $237,766.04

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