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Question 1:Imagine two investment projects (A and B)
Question 1:Imagine two investment projects (A and B). Both of their investment periods are longer than 7 years (na, nb>7).They have same investment periods (na=nb). Give cash inflows, outflows and interest rate values on your own. Assume that interest rate is fixed over time, there is no inflation. Calculate Net Present Worth, Net Future Worth of both projects. Interpret your findings.
Expert Solution
Answer:
Project A:
Initial investment=$12000, Assumed cash inflows per year=$9000, Assumed cash outflows per year=$6000 and interest rate=15%.
| Year | Cash inflows | Cash outflows | Net cashflow | PV factor @15% | Present worth | FV factor@15% | Future worth |
| 0 | 12000 | -12000 | 3.518 | -42216 | |||
| 1 | 9000 | 6000 | 3000 | 0.8696 | 2608.8 | 3.059 | 9177 |
| 2 | 9000 | 6000 | 3000 | 0.7561 | 2268.3 | 2.66 | 7980 |
| 3 | 9000 | 6000 | 3000 | 0.6575 | 1972.5 | 2.313 | 6939 |
| 4 | 9000 | 6000 | 3000 | 0.5718 | 1715.4 | 2.011 | 6033 |
| 5 | 9000 | 6000 | 3000 | 0.4972 | 1491.6 | 1.749 | 5247 |
| 6 | 9000 | 6000 | 3000 | 0.4323 | 1296.9 | 1.521 | 4563 |
| 7 | 9000 | 6000 | 3000 | 0.3759 | 1127.7 | 1.322 | 3966 |
| 8 | 9000 | 6000 | 3000 | 0.3269 | 980.7 | 1.15 | 3450 |
| Net worths | 1461.9 | 5139 |
Project B:
Initial investment=$13000, Assumed cash inflows per year=$9000, Assumed cash outflows per year=$6000 and interest rate=15%.
| Year | Cash inflows | Cash outflows | Net cashflow | PV factor @15% | Present worth | FV factor@15% | Future worth |
| 0 | 13000 | -13000 | 3.518 | -45734 | |||
| 1 | 9000 | 6000 | 3000 | 0.8696 | 2608.8 | 3.059 | 9177 |
| 2 | 9000 | 6000 | 3000 | 0.7561 | 2268.3 | 2.66 | 7980 |
| 3 | 9000 | 6000 | 3000 | 0.6575 | 1972.5 | 2.313 | 6939 |
| 4 | 9000 | 6000 | 3000 | 0.5718 | 1715.4 | 2.011 | 6033 |
| 5 | 9000 | 6000 | 3000 | 0.4972 | 1491.6 | 1.749 | 5247 |
| 6 | 9000 | 6000 | 3000 | 0.4323 | 1296.9 | 1.521 | 4563 |
| 7 | 9000 | 6000 | 3000 | 0.3759 | 1127.7 | 1.322 | 3966 |
| 8 | 9000 | 6000 | 3000 | 0.3269 | 980.7 | 1.15 | 3450 |
| Net worths | 461.9 | 1621 |
We can see that with the increase in investment in project B by $1000, Net present worth of project B is decreased by $1000 only whereas decrease in future worth is larger because in it future value of the present investment is increased by $1000*3.518=$3518.
If Net present and future worths are positive then the project is acceptable and the projects with higher Net worth and future worth are preffered.
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