Question

You have been offered a unique investment opportunity. If you invest $10,000 today, you will receive $500 one year from now, $1,500 two years from now, and $10,000 ten years from now.
a) What is the NPV of the opportunity if the interest rate is 12% per year? Should you take the opportunity?
b) What is the NPV of the opportunity if the interest rate is 8% per year? Should you take it now?

Answer 1

Answer:

Instructions are listed below.

Explanation:

Giving the following information:

Io= -10,000

Cf1= 500

Cf2= 1,500

Cf3= 10,000

Based on this information and using the following formula, we need to calculate the net present value:

NPV= -Io + ∑[Cf/(1+i)^n]

Cf= cash flow

A) i= 0.12

Cf1= 500/1.12= 446.43

Cf2= 1,500/1.12^2= 1,195.80

Cf3= 10,000/1.12^3= 7,117.80

Total= 8,760

NPV= -10,000 + 8,760= -1,240

Under these circumstances, the investment shouldn't be done.

B) i= 0.08

Cf1= 500/1.08= 462.96

Cf2= 1,500/1.08^2= 1,286

Cf3= 10,000/1.08^3= 7,983.32

Total= 9,732.28

NPV= -10,000 + 9,732.28= 267.72

Under these circumstances, the investment shouldn't be done.