Question

Example:

Consider two projects. The first project pays benefits of $90 today and nothing else. The second project pays nothing today, nothing one year from now, but $100 two years from now. Which project would be preferred if the discount rate were 2%? What if the rate increased to 10%?

- For a discount rate of 2%, the present value calculations would be $90 for project one and $96.12 for project two; therefore, project two is preferred. At a rate of 10%, the PV of project one is still $90. For project two, the PV is now 100/1.1^2= 82.6; therefore, project one is preferred.

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How can I solve this questions below???????????????????????????????????

Consider two projects. The first project pays benefits of $90 today and nothing else. The second project pays nothing today, nothing one year from now, but $100 two years from now. Which project would be preferred if the discount rate were 2%? What if the rate increased to 8%?

Answer 1

CASE 1

Discount rate = 2% or 0.02

The first project pays benefit of $90 today.

The present value of benefit received today is amount itself.

Thus,

The present value of benefits from first project is $90.

The second project pays $100 two years from now.

Calculate the present value -

PV = $100/(1+0.02)² = $100/(1.02)² = $100/1.0404 = $96.12

The present value of bebefits from Project 2 is $96.12

The present value of benefits from Project 2 is higher.

So, at discount rate of 2%, Project 2 would be preferred.

CASE 2

Discount rate = 8% or 0.08

The first project pays benefit of $90 today.

The present value of benefit received today is amount itself.

Thus,

The present value of benefits from first project is $90.

The second project pays $100 two years from now.

Calculate the present value -

PV = $100/(1+0.08)² = $100/(1.08)² = $100/1.1664 = $85.73

The present value of bebefits from Project 2 is $85.73

The present value of benefits from Project 1 is higher.

So, at discount rate of 8%, Project 1 would be preferred.