Figure 14-6.Present value of $1
Present value of an Annuity of $1

-Refer to Figure 14-6. Roman Knoze is considering two investments. Each will cost $20,000 initially. Project 1 will return annual cash flows of $10,000 in each of three years. Project 2 will return $5,000 in year 1, $10,000 in year 2, and $15,000 in year 3. Roman requires a minimum rate of return of 10%. What is the net present value of Project 2?

Question

Figure 14-6.Present value of $1
  Present value of an Annuity of $1
 
-Refer to Figure 14-6. Roman Knoze is considering two investments. Each will cost $20,000 initially. Project 1 will return annual cash flows of $10,000 in each of three years. Project 2 will return $5,000 in year 1, $10,000 in year 2, and $15,000 in year 3. Roman requires a minimum rate of return of 10%. What is the net present value of Project 2?

Quizplus · Accepted Answer

To calculate the net present value (NPV) of Project 2, we discount each of its cash flows back to the present value at the required rate of return of 10%. The formula for NPV is: NPV = (Cash Flow in Year 1 / (1+r)^1) + (Cash Flow in Year 2 / (1+r)^2) + (Cash Flow in Year 3 / (1+r)^3) - Initial Investment, where r is the rate of return (10% or 0.10 in this case).For Project 2:- Year 1 cash flow = $5,000- Year 2 cash flow = $10,000- Year 3 cash flow = $15,000- Initial investment = $20,000NPV = ($5,000 / (1+0.10)^1) + ($10,000 / (1+0.10)^2) + ($15,000 / (1+0.10)^3) - $20,000NPV = ($5,000 / 1.10) + ($10,000 / 1.21) + ($15,000 / 1.331) - $20,000NPV = $4,545.45 + $8,264.46 + $11,260.09 - $20,000NPV ≈ $4,070Therefore, the correct answer is E) $4,070, which is the net present value of Project 2.

Figure 14-6.Present Value of $1