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Tanya [424]
2 years ago
8

You are considering two projects. Project A has projected cash flows of $6,500, $4,500, and $2,500 for the next three years, res

pectively. Project B has projected cash flows of $2,500, $4,500, and $6,500 for the next three years, respectively. Assuming both projects have the same initial cost, you know that:
Business
1 answer:
Zinaida [17]2 years ago
7 0

Answer:

Project A is more valuable than Project B given a positive discount rate.

Explanation:

Let us assume the Discount Rate be r and cash flow for year n be CFn

Also

Let us assume initial Investment be X

So,  

NPV = ΣCFn ÷ (1+r)^n

NPVA = - X + 6500 ÷ (1 + r) + 4500 ÷ (1+r)^2 + 2500 ÷ (1+r)^3

NPVB = - X + 2500 ÷ (1+r) + 4500 ÷ (1+r)^2 + 6500 ÷ (1+r)^3  

NPVA - NPVB = - X + 6500 ÷ (1+r) + 4500 ÷ (1+r)^2 + 2500 ÷ (1+r)^3 - (- X + 2500 ÷ (1+r) + 4500 ÷ (1+r)^2 + 6500 ÷ (1+r)^3)

= 4000 ÷ (1+r) - 4000 ÷ (1+r)^3 = 4000(1 ÷ (1+r) - 1 ÷ (1+r)^3)

In the case when

Ir > 0, 1 ÷ (1+r) > 1 ÷ (1+r)^3

So,  

NPVA - NPVB > 0 => NPVA > NPVB

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Explanation:

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Problem 5-1 Simple Interest versus Compound Interest [LO1] First City Bank pays 8 percent simple interest on its savings account
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