Question

6) You are trying to decide from three investment opportunities with the following end-of-year CFs. Which investment would you choose assuming a 10% discount rate? Remember to show what each investment is worth to you today, to explain your choice. End of Year 400 400 400 400 500 400 400 400 400 600 6 600

Answer 1

The option which gives the maximum net present value will be chosen

Present value factors

= 1 / (1 + r) ^ n

Where,

r = Rate of interest = 10% or 0.10

n = Years = 0 to 7

So, PV Factor for year 2

= 1 / (1.10^2)

= 1 / 1.21

= 0.826446

The following table shows the calculations:

Option A
Calculations	Years	0	1	2	3	4	5	6	7
A	Cash Flow	0	400	400	400	400	0	0	0
B	PV Factors	1	0.909091	0.826446	0.751315	0.683013	0.620921	0.564474	0.513158
C = A x B	Present Values	0	363.6364	330.5785	300.5259	273.2054	0	0	0
D = Sum C	Net Present value	1267.95
Option B
Calculations	Years	0	1	2	3	4	5	6	7
A	Cash Flow	0	0	0	0	400	400	400	400
B	PV Factors	1	0.909091	0.826446	0.751315	0.683013	0.620921	0.564474	0.513158
C = A x B	Present Values	0	0	0	0	273.2054	248.3685	225.7896	205.2632
D = Sum C	Net Present value	952.63
Option C
Calculations	Years	0	1	2	3	4	5	6	7
A	Cash Flow	0	500	0	0	600	0	0	600
B	PV Factors	1	0.909091	0.826446	0.751315	0.683013	0.620921	0.564474	0.513158
C = A x B	Present Values	0	454.5455	0	0	409.8081	0	0	307.8949
D = Sum C	Net Present value	1172.25

So, as per above calculations, Investment A should be chosen as it gives the maximum net present value