Question

4. Harrison, Inc. is considering two investment opportunities. Each investment costs $7.000 (i.e.. year 0 cash flow associated with each opportunity is -$7.000) and will provide the same total future cash inflows. The schedule of estimated cash receipts for each investment follows (assume cash is received at year-end): Year Investment Investment II $4,000 $2,500 $2,000 $2,000 $3,000 $1,500 $4,000 Total Cash Flow $10,000 $10,000 Which investment should Harrison choose assuming all other variables for the two investments are the same (specifically, the appropriate discount rate for both investments is 4% p.a.)? a. Harrison should be indifferent between the two investments since they provide the same total cash inflows. b. Harrison should choose Investment I because of the time value of money. c. Harrison should be indifferent between the two investments since the initial cash outflow is the same. d. Harrison should choose Investment II because it generates larger cash inflows at the end of the investment's useful life. e. None of the answers listed above are correct. 5. Which of the following will decrease the present value of the mixed cash flows for years I through of S1,000; $4,000; $9,000; $5,000; and $2.000 respectively given a 10% discount rate? (Choose all that apply - this is an all or nothing problem, if you choose an option that is wrong or do nor choose an option that is correct, your entire answer will be marked wrong). a. Decrease the discount rate by 2%. b. Switch cash flows for years 1 and 5 so that year I is $2.000 and year 5 is $1.000. c. Switch cash flows for years 3 and 4 so that year 3 is $5,000 and year 4 is S9,000. d. Switch cash flows for years 2 and 5 so that year 2 is $2.000 and years is $4.000. e. Switch cash flows for years 3 and I so that year is $9.000 and year 3 in 1.000,

Answer 1

4. b The answer is Harrison should choose Investment 1 because of time value of money. The PV os all cash inflows of Investment 1 is $9218(3846+2312+1778+1282) amd the PV of all cash inflows in Investment 2 is 8897 (962+1849+2667 +3419). Since the NPV of Investment 1 would be greater than Investment 2 because of same intial cost and time value of money, we would choose the 1st investment.

5. The present value of cash inflows is $15,633.(1000*.9091+ 4000*.8264 +9000*.7513 +5000*.6830 + 2000*.6210 )

Decreasing the discount rate by 2% will only increase the present value.

Switching cash flows for years 1 and 5 will increase the PV to $15,922.

Switching cash flows for years 3 and 4 will decrease the PV to $15,360

Hence, we do not have to evaluate any further options. The correct option is c because it decreases the present value of mixed cash flows.