Question

The market interest rate is 10%. An investment project requires an investment of $1000 today, and promises to yield $500 at the end of each year for 3 years. At the end of year 4 there will be a one-time cleanup cost of $50.

a. Use a number line to show each of these cash flows, with the appropriate + or – sign.

b. Without solving, write the numerical expression that would yield the net present value of this investment

c. Briefly state the rule you should use to decide whether or not to make this investment.

Answer 1

Year 0 = -1000
Year 1 = 500
Year 2 = 500
Year 3 = 500
Year 4 = -50

NPV = -1000 + (500/1.1) + (500/1.1^2) + (500/1.1^3) + (-50/1.1^4)

IF the calculated NPV is positive then make the investment and if it is negative reject the investment.