Question

Provided that your discount rate is 5%, explain whether or not you should adopt an investment project yielding the following cash flow.

This year (investment). -$10,000

Yield (1 year later ) $6000

Yield (2 years later) $5000

Answer 1

Answer

You should do the Investment If Net Present Value of the entire cash flow is 0. While Calculating the NPV we considers incurred or investment made as negative and Amount received or Yield as positive.

Present Value of amount received after n years is given by :

PV = A/(1 + r)ⁿ

where A = Amount received after n years, r = interest rate(or discount rate) = 5% = 0.05 and n = time.

Hence, Net Present Value is given by :

NPV = -10,000/(1 + 0.05)⁰ + 6,000/(1 + 0.05)¹ + 5,000/(1 + 0.05)²

=> NPV = 249.43 > 0.

(Note here we have -10,000 because we incurred this cost and 6000 and 5000 are positive because he received the Amount)

As, Net Present Value > 0. Thus, he should made this investment

Hence, Answer is Yes You should adopt this investment project.