Question

Your firm has identified three potential investment projects. The projects and their cash flows are shown​ here:

Project	Cash Flow Today ​(millions)		Cash Flow in One Year ​(millions)
A	−$7		$17
B	$6		$6
C	$15		−$14

Suppose all cash flows are certain and the​ risk-free interest rate is

7%.

a. What is the NPV of each​ project?

b. If the firm can choose only one of these​ projects, which should it​ choose?

c. If the firm can choose any two of these​ projects, which should it​ choose?

Answer 1

a

Project A
Discount rate	0.07
Year	0	1
Cash flow stream	-7	17
Discounting factor	1	1.07
Discounted cash flows project	-7	15.88785
NPV = Sum of discounted cash flows
NPV Project A =	8.89
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Project B
Discount rate	0.07
Year	0	1
Cash flow stream	6	6
Discounting factor	1	1.07
Discounted cash flows project	6	5.607477
NPV = Sum of discounted cash flows
NPV Project B =	11.61
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Project C
Discount rate	0.07
Year	0.00%	1
Cash flow stream	15	-14
Discounting factor	1	1.07
Discounted cash flows project	15	-13.0841
NPV = Sum of discounted cash flows
NPV Project C =	1.92
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

b

Choose project B as it has highest NPV

c

Choose project B and project A