3. Calculate the NPV and rate of return for each of the following investments. The opportunity cost of capital is 20 percent for all four investments.
1- Initial Cash Flow: -10,000 C0 Cash Flow in Year 1, C1: +18,000
PV: 18000 / 1.20 = 15000 NPV: 15000 – 8000 = 7000
rate of return: 18000 - 10000 / 10000 = 80%
2- Initial Cash Flow: -5,000 C0 Cash Flow in Year 1, C1: +9,000
PV: 9000 / 1.20 = 7500 NPV: 7500 - 4000 = 3500
rate of return: 9000 - 5000 / 5000 = 80%
3- Initial Cash Flow: -5,000 C0 Cash Flow in Year 1, C1: +5,700
PV: 5700 / 1.20 = 4750 NPV: 4750 – 700 = 4050
rate of return: 5700 - 5000 / 5000 = 14%
4- Initial Cash Flow: -2,000 C0 Cash Flow in Year 1, C1: +4,000
PV: 4000 / 1.20 = 3333 NPV: 3333 – 2000 = 1333
rate of return: 4000 - 2000 / 2000 = 100%
a. Which investment is most valuable? The fourth investment is the most valuable at 100% return
b. Suppose each investment would require use of the same parcel of land. Therefore
you can take only one. Which one? Hint: What is the firm’s objective: to earn a high
rate of return or to increase firm value?
In this example, the assumption is that the firm’s objective is to earn a high rate of return, correct? So wouldn’t it make sense to also choose the fourth investment?
Flora
1- Initial Cash Flow: -10,000 C0 Cash Flow in Year 1, C1: +18,000
PV: 18000 / 1.20 = 15000 NPV: 15000 – 8000 = 7000
rate of return: 18000 - 10000 / 10000 = 80%
2- Initial Cash Flow: -5,000 C0 Cash Flow in Year 1, C1: +9,000
PV: 9000 / 1.20 = 7500 NPV: 7500 - 4000 = 3500
rate of return: 9000 - 5000 / 5000 = 80%
3- Initial Cash Flow: -5,000 C0 Cash Flow in Year 1, C1: +5,700
PV: 5700 / 1.20 = 4750 NPV: 4750 – 700 = 4050
rate of return: 5700 - 5000 / 5000 = 14%
4- Initial Cash Flow: -2,000 C0 Cash Flow in Year 1, C1: +4,000
PV: 4000 / 1.20 = 3333 NPV: 3333 – 2000 = 1333
rate of return: 4000 - 2000 / 2000 = 100%
a. Which investment is most valuable? The fourth investment is the most valuable at 100% return
b. Suppose each investment would require use of the same parcel of land. Therefore
you can take only one. Which one? Hint: What is the firm’s objective: to earn a high
rate of return or to increase firm value?
In this example, the assumption is that the firm’s objective is to earn a high rate of return, correct? So wouldn’t it make sense to also choose the fourth investment?
Flora