The
cost of capital for a firm is 10 percent.
The firm has two possible investments with the following cash inflows:
A B
Year 1 $300 $200
Year 2 200 200
Year 3 100 200
a.
Each investment costs $480. What
investment(s) should the firm make according to net present value?
b.
What is the internal rate of return for the two investments? Which investment(S) should the firm
make? Is this the same answer you
obtained in part a?
c.
If the cost of capital rises to 14 percent, which investment(s) should the firm
make?
TUTORIAL PREVIEW
a. Determination of net present value:
year
|
Project A
|
Project B
| ||||
Cash flow
|
PV factor @ 10%
|
PV of cash flows
|
Cash flow
|
PV factor @ 10%
|
PV of cash flows
| |
1
|
300
|
0.909
|
272.7
|
200
|
0.909
|
181.8
|
2
|
200
|
0.826
|
165.2
|
200
|
0.826
|
165.2
|
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