A firm has the following investment alternatives. Each one lasts a year INVESTME

ID: 2715806 • Letter: A

Question

A firm has the following investment alternatives. Each one lasts a year

INVESTMENT

Cash Inflow

$1,150

$560

$600

Cash Outflow

$1,000

$500

The firm’s cost of capital is 7 percent. A and B are mutually exclusive, and B and C are mutually exclusive.

What is the net present value of investment A? Investment B? Investment C?

What is the internal rate on investment A? Investment B? Investment C?

Which investment(s) should the firm make? Why?

If the firm had unlimited sources of funds, which investment(s) should it make? Why?

If there were another alternative, investment D, with an internal rate of return of 6 percent, would that alter your answer to question (d)? Why?

If the firm’s cost of capital rose to 10 percent, what effect would that have on investment A’s internal rate of return?

INVESTMENT

Cash Inflow

$1,150

$560

$600

Cash Outflow

$1,000

$500

NPV A=-1000+1150/1.07=$74.77

B=-500+560/1.07=$23.36

C=-500+600/1.07=$60.75

Internal Rate on invetemnt A=+(1150-1000)/1000*100=15%

B=(560-500)/500*100=12%

C=(600-500)/500*100=20%

On the basis of NPV,A is better yielding more income

on the basis of internal rate ,C is better yielding highest retrun

If the firm had unlimited sources of funds then it is better to invest C and later A, but not B because both A and B are mutuvally exclusive

Investment d should not supposed to investment yeildng less IR comapare to A, B and C

NPV of A=-1000+1150/1.1=$45.45

NPV redused to S45.45

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