Question

For the cash flows below, if 6% is the minimum attractive rate of return, which alternative should be selected? Use rate of return analysis. alternative 1 alternative 2 Year 0 -$5000 -$5000 -3000 2000 4000 2000 2000 4000 4000 2000

Answer 1

rate of return = r

alternative 1:

5000 + 3000/(1 + r) = 4000/(1 + r)² + 4000/(1 + r)³ + 4000/(1 + r)⁴

r = 16.94%

alternative 2:

5000 = 2000/(1 + r) + 2000/(1 + r)² + 4000/(1 + r)³ + 4000/(1 + r)⁴

r = 21.86%

Alternative 2 should be selected (higher rate of return)