A company can invest $20,000,000 for three years in Option A paying out $7,500,000, $8,500,000, and $9,500,000 respectively. For an investment of $1,500,000, Option B will pay out $650,000, $750,000, and $850,000. Where should the company invest its money given a hurdle rate of 9%?

Question

Quizplus · Accepted Answer

To determine the best choice, we need to calculate the NPV and IRR of both options.

Option A:

NPV = -$20,000,000 + ($7,500,000 / 1.09) + ($8,500,000 / 1.09^2) + ($9,500,000 / 1.09^3) = $1,251,193.77
IRR = 12.22%

Option B:

NPV = -$1,500,000 + ($650,000 / 1.09) + ($750,000 / 1.09^2) + ($850,000 / 1.09^3) = -$315,147.15
IRR = 10.39%

The NPV of Option A is positive, indicating that it generates more value than the initial investment, while the NPV of Option B is negative, meaning that it results in a loss of value. Therefore, the best choice would be Option A as it has the higher NPV.

A Company Can Invest $20,000,000 for Three Years in Option