Question

A company has the following two projects: Time 1 Time 3 Time 0 Time 2 Project 1 150 150 150 -300 Project 2 -300 350 Suppose that Jane is the only shareholder of this company and she is 99 years old. Since she is very old, she wants to spend all her wealth within a year. What project should the company invest in? Assume a 10% discount rate. O A. Project 1 O B. Project 2 O C. N/A D. N/A

Answer 1

Answer: Option A is correct. The company should invest in Project 1.

The company should invest in the project that would give higher net present value.
Net present value=-Initial investment + Present value of future cash flows at the discount rate of 10%

Project 1:
Net present value=-300 + 150/(1+10%)^1+150/(1+10%)^2+150/(1+10%)^3
=-300 + 150/1.1+150/1.21+150/1.331
=-300 + 136.3636364+123.9669421+112.6972201
=73.0277986 or $73.03 (Rounded to 2 decimal places)

Project 2:
Net present value=-300 + 350/(1+10%)^1+0/(1+10%)^2+0/(1+10%)^3
=-300 + 350/1.1+0
=18.18181818 or $18.18 (Rounded to 2 decimal places)

Answer: As the net present value of project 1 is higher than project 2, project 1 should be accepted.
Alternative solution using excel:

1 Project 1 Project 2 2 Year Cash flow Cash flow Year -300 -300 150 350 2 150 3 150 3 7 NPV= 73.03 NPV= 18.18 8 Formula used: N3+NPV(10%,N4:N6) Formula used: Q3+NPV(10%,Q4:Q6)

Answer: As the net present value of project 1 is higher between the two projects, it should be accepted.