Question

Calculate the NPV, and rate of return for each of the following investments. The annual interest rate is 10%. Initial Cash flow Investment Cash Flow One Year Later -$5,000 $9,000 -$20,000 $30,000 -$1,000 $1,250 -$6,000 $6,540 co b. Calculate the NPV for each investment. Calculate the rate of return for each investment. Which of these projects would you accept? Why? If you could select only one of these projects, which would you choose? Why? o o

Answer 1

Question a:

Calculation of NPV for each investment

NPV is calculated with the below formula

NPV = Present value of cash inflows - Initial Cash Flow

NPV of Investment 1 = [$9,000 / (1+10%)^1] - $5,000 = $8,181.81818 - $5,000 = $3,181.82

NPV of Investment 2 = [$30,000 / (1+10%)^1] - $20,000 = $27,272.7273 - $20,000 = $7,272.73

NPV of Investment 3 = [$1,250 / (1+10%)^1] - $1,000 = $1,136.36364 - $1,000 = $136.36

NPV of Investment 4 = [$6,540 / (1+10%)^1] - $6,000 = $5,945.45455 - $6,000 = -$54.55

Question b:

Calculation of Rate of Return for each investment

Rate of Return can be calculated as follows

Rate of Return = ( cash inflows - Initial Inflow ) / Initial Inflow

Rate of Return of Investment 1 = ($9,000 - $5,000) / $5,000 = $4,000 / $5,000 = 0.8 = 80%

Rate of Return of Investment 2 = ($30,000 - $20,000) / $20,000 = $10,000 / $20,000 = 0.5 = 50%

Rate of Return of Investment 3 = ($1,250 - $1,000) / $1,000 = $250 / $1,000 = 0.25 = 25%

Rate of Return of Investment 4 = ($6,540 - $6,000) / $6,000 = $540 / $6,000 = 0.09 = 9%

Question 3:

Investment 1 can be accepted because NPV($3,182.82) > 0 and Rate of Return (80%) > Annual Interest rate (10%)

Investment 2 can be accepted because NPV($7,172.73) > 0 and Rate of Return (50%) > Annual Interest rate (10%)

Investment 3 can be accepted because NPV($136.36) > 0 and Rate of Return (25%) > Annual Interest rate (10%)

Investment 4 can be accepted because NPV(-$54.55) < 0 and Rate of Return (9%) < Annual Interest rate (10%)

Therefore, Investment 1,2 and 3 should be accepted

Question 4:

>> Using NPV of investment Criteria, Investment 2 should be accepted as NPV of Investment 2 is higher than other investments

>> Using Rate of Return on investment Criteria, Investment 1 should be accepted as Rate of Return of investment 1 is higher than other investments