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	−$6		$17
B	$3		$6
C	$16		−$5

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	7.000%
Year	0	1
Cash flow stream	-6	17
Discounting factor	1.000	1.070
Discounted cash flows project	-6.000	15.888
NPV = Sum of discounted cash flows
NPV Project A =	9.89
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project B
Discount rate	7.000%
Year	0	1
Cash flow stream	3	6
Discounting factor	1.000	1.070
Discounted cash flows project	3.000	5.607
NPV = Sum of discounted cash flows
NPV Project B =	8.61
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project C
Discount rate	7.000%
Year	0	1
Cash flow stream	16	-5
Discounting factor	1.000	1.070
Discounted cash flows project	16.000	-4.673
NPV = Sum of discounted cash flows
NPV Project C =	11.33
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

b

Choose project C as it has highest NPV

c

Choose project C and A as B has the lowest NPV