Question

Consider the following investment cash flows:

Year	Cash Flow
0	($16,000)
1	3,000
2	4,000
3	5,000
4	6,000
5	7,000

a. What is the return expected on this investment measured in dollar terms if the opportunity cost is 6%.

b. What is the return on this investment measured in percentage terms?

c. Is the investment profitable? Explain your answer.

Answer 1

		i	ii	iii=i*ii
	Year	Cash Flow	PVIF @ 6%	present value
	0	($16,000)	1	($16,000)
	1	3,000	0.94339623	$2,830
	2	4,000	0.88999644	$3,560
	3	5,000	0.83961928	$4,198
	4	6,000	0.79209366	$4,753
	5	7,000	0.74725817	$5,231
				$4,572
Answer 1)	Return in dollar term =			$4,572
Answer 2)	Return on investment is IRR
	Let IRR be 14% and 15%. Threfore NPV will be as per below table
		i	ii	iii		iv=i*ii	v=i*iii
	Year	Cash Flow	PVIF @ 14%	PVIF @ 15%		PV @ 14%	PV @ 15%
	0	($16,000)	1	1		($16,000)	($16,000)
	1	3,000	0.87719298	0.869565217		$2,632	$2,609
	2	4,000	0.76946753	0.756143667		$3,078	$3,025
	3	5,000	0.67497152	0.657516232		$3,375	$3,288
	4	6,000	0.59208028	0.571753246		$3,552	$3,431
	5	7,000	0.51936866	0.497176735		$3,636	$3,480
						$272	($168)
	we can see that IRR should be in between 14% and 15% .
	Lower rate +(Lower rate NPV/(Lower rate NPV-Higher rate NPV))*Difference in rate
	=14%+((272/(272--168))*1%)
	14.62%
	Therefore return on investment =				14.62%
Answer 3)	Project should be accepted and investment is profitable. This is because NPV is positive at 6% rate of return and also IRR is higher than 6%