Question

In: Finance

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

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?

Solutions

Expert Solution

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


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