A risky $400,000 investment is expected to generate the following cash flows: Ye

Question

A risky $400,000 investment is expected to generate the following cash flows: Year 1 2 3 4 $145,300 $175,445 $156,788 $145,000 A. If the firm's cost of capital is 10 percent, should the investment be made? B. An alternative use for the $400,000 is a four-year U.S. Treasury bond that pays $28,000 annually and repays the $400,000 at maturity. Management believes that the cash inflows from the risky investment are equivalent to only 75 percent of the certain investment, which pays 7 percent. Does this information alter the decision in a?

Explanation / Answer

I have no idea about b. But for a, I can solve it. Here is the solution. NPV = (-400000)+(145300/(1.1^1))+(175445/(1.1^2))+(156788/(1.1^3))+(145000/(1.1^4)) = 93920.87289 > 0 So investment should be made.

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