Problems4 If the cost of capital is 9 percent and an investment costs $56,000, s

Question

Problems4 If the cost of capital is 9 percent and an investment costs $56,000, should you make this investment if the estimated cash flows are $5,000 for years 1 through 3, $10,000 for years 4 through 6, and $15,000 for years 7 through 10? Problem 5 An investment costs $10,000 and offers annual cash inflow of $1,770 for ten years. According to both the net present value and internal rate of return methods of capital budgeting, should the firm make this investment if its cost of capital is (a) 10 percent or (b) 14 percent?

Explanation / Answer

Problem 4 NPV = -$56,000 + $5,000/1.09 + $5,000/1.09^2 + $5,000/1.09^3 + $10,000/1.09^4 + $10,000/1.09^5 + $10,000/1.09^6 + $15,000/1.09^7 + $15,000/1.09^8 + $15,000/1.09^9 + $15,000/1.09^10 = $5,178.80 Yes, we should make the investment as NPV is positive Problem 5 (a) 10 percent NPV = -$10,000 + $1,770/1.1 + $1,770/1.1^2 + $1,770/1.1^3...................$1,770/1.1^10 NPV = $875.88 If cost of capital is 10%, we should make the investment (b) 14 percent NPV = -$10,000 + $1,770/1.14 + $1,770/1.14^2 + $1,770/1.14^3...................$1,770/1.14^10 NPV = -$767.48 If cost of capital is 14%, we should not make the investment

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