A firm is considering an investment that will cost $2 million today and $2 million a year from now. It will generate revenues of $1 million a year for five years, beginning two years from now. If the interest rate is 10 percent, the firm should

Question

Quizplus · Accepted Answer

To determine whether this investment is worthwhile, we need to calculate the net present value of the investment. We can use the formula:

NPV = (CF1 / (1+r)^1) + (CF2 / (1+r)^2) + ... + (CFn / (1+r)^n) - Initial Investment

where:
CF = cash flows
r = discount rate
n = number of periods

Using the information given in the problem:

NPV = (0 + 0 + 1 + 1 + 1 + 1) / (1+0.1)^2 - 2 - 2(1+0.1)^(-1) = -0.17

Since the NPV is negative, the present value of the net revenues is less than the present value of the investment spending. Therefore, the firm should not make the investment, making choice A the best answer.

A Firm Is Considering an Investment That Will Cost $2