Question

If you invest $1,000 today, you will receive $400 in one year from now and $750 in two years from now. If your require a 12% return on investments of this risk, should you take the investment?

Answer 1

Since the cash flows are r at different points in time, we need to calculate the NPV of this investment.

Initial investment, C₀ = 1,000

Cash flow at the end of year 1, C₁ = 400

Cash flow at the end of year 2, C₂ = 750

Discount rate, R = 12%

Hence, NPV

$= - C_{0} + \frac{C_{1}}{1+R} + \frac{C_{2}}{(1+R)^{2}} = - 1000 + \frac{400}{1+0.12} + \frac{750}{(1+0.12)^{2}}$

= - $ 44.96

Since, this is a negative NPV project, I will not undertake this investment.