Question

Which investment has a higher NPV (at an interest rate of 10%):

a) An investment that costs $500 today and returns $100 / year for the next 6 years

b) an investment that costs %600 today and returns $90 per year for the next 7 years

Answer 1

a.Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=100/1.1+100/1.1^2+100/1.1^3+100/1.1^4+100/1.1^5+100/1.1^6

=$435.53

NPV=Present value of inflows-Present value of outflows  

=435.53-500

=$-64.47(Approx)(Negative)

b.Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=90/1.1+90/1.1^2+90/1.1^3+90/1.1^4+90/1.1^5+90/1.1^6+90/1.1^7

=438.16

NPV=Present value of inflows-Present value of outflows  

=438.16-600

=$-161.84(Approx)(Negative)

Hence higher NPV is of Case A.