A £25 investment produces £27.50 at the end of the year.Which of the following is true?
A)NPV is positive if the interest rate is less than 10%.
B)NPV is non-zero if the interest rate is equal to 10%.
C)NPV is positive if the interest rate is more than 10%.
D)NPV is negative if the interest rate is less than 10%.
E)None of the above.

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV) of an investment, we need to discount the future cash flows back to present value using a discount rate. If the NPV is positive, then the investment is a good one.

In this case, the investment costs £25 and produces £27.50 at the end of the year, so the cash flow is £2.50.

If we assume an interest rate of 10%, then the present value of the cash flow is:

£2.50 / (1 + 0.10) = £2.27

This means that if the interest rate is lower than 10%, the NPV will be positive:

NPV = -£25 + £2.27 = -£22.73

If the interest rate is equal to or greater than 10%, the NPV will be negative:

NPV = -£25 + £2.27 = -£22.73

Therefore, choice A is correct.

A £25 Investment Produces £27