Question

Mutually exclusive investments and risk Personal Finance Problem Lara Fredericks is interested in two mutually exclusive investments. Both investments cover the same time horizon of 6 years. The cost of the first investment is $9,800, and Lara expects equal and consecutive year-end payments of $3,100. The second investment promises equal and consecutive payments of $4,400 with an initial outlay of $11,800 required. The current required return on the first investment is 8.8%, and the second carries a required return of 10.8%. a. What is the net present value of the first investment? b. What is the net present value of the second investment? c. Being mutually exclusive, which investment should Lara choose? d. Which investment is relatively more risky? Explain.

Answer 1

		Option 1
				In $					In $
	Year	Cash Inflows	Discount factor 8.8%	Discounted Value		Year	Cash Outlows	Discount factor 8.8%%	Discounted value
	1	3100	0.92	2849.26		0	9800	1.00	9800.00
	2	3100	0.84	2618.81				PVCO	9800.00
	3	3100	0.78	2406.99
	4	3100	0.71	2212.31
	5	3100	0.66	2033.37
	6	3100	0.60	1868.91
			PVCI	13989.66
Answer (a)		NPV = PVCI - PVCO	4189.66	$
		Option 2
				In $					In $
	Year	Cash Inflows	Discount factor 10.8%	Discounted Value		Year	Cash Outlows	Discount factor 10.8%	Discounted value
	1	4400	0.90	3971.12		0	11800	1.00	11800.00
	2	4400	0.81	3584.04				PVCO	11800.00
	3	4400	0.74	3234.70
	4	4400	0.66	2919.40
	5	4400	0.60	2634.84
	6	4400	0.54	2378.01
			PVCI	18722.11
Answer (b)		NPV = PVCI - PVCO	6922.11	$
Answer (c) Since NPV of Second Investment Is Higher hence it Should Be Accepted
Answer (d) Since The Required Rate of Return of Second Investment Is Higher hence it is Comparatively More Risky