Question

(8) Two projects have equal net present values when calculated using a 6% annual effective interest rate. Project 1 requires an investment of $20,000 immediately and will return $8,000 at the end of one year and $15,000 at the end of two years. Project 2 requires investments of $10,000 immediately and $X in two years. It will return $3,000 at the end of one year and $14,000 at the end of three years. Find the difference in the net present values of the two projects if they are calculated using a 5% annual effective interest rate.

Answer 1

Answer:

I will be preferable the first project as their present value is greater than project 2

Explanation:

We will calcualte the discounted cash flow at the given rate of 6% and then compare with the initial invesmtnet

Project 1

-20,000

+8,000 / 1.06

+15,000 /1.06^2

NPV  897.12

If used 5% interest rate

-20,000

+8,000 / 1.05

+15,000 /1.05^2

NPV  1224.49

Project 2

-10,000

+ 3,000/1.06

+    X/1.06^2

+14,000/1.06^3

NPV  897.12

X = -4143.543138

There is a second investment of 4,143.54

If discounted at 5%

-10,000

+3,000/1.05

-4,143.54/1.05^2

+14,000/1.05^3

1192.556311

Difference: 1,192.55 - 1,224.49