Question

15. A firm is considering a new venture that would cost $3.5million, which is expected to yield $1.2 million in annual profits (each year) for the next four years. The current interest rate is 3%. The firm should:

a.) undertake the project regardless of the interest rate.

b.) invest in this new venture because the present value of net gain would be $960,000 (approx.)

c.) invest in this new venture because the present value of net gain would be $660,000 (approx.)

d.) not undertake the project since the costs are not offset by profits

Answer 1

Present value of project = -3500000 + 1200000*(P/A,3%,4)

= -3500000 + 1200000*3.717098

= 960518.08

So option B is correct i.e. invest in this new venture because the present value of net gain would be $960,000 (approx.)