Sun Systems Company has two investment opportunities. Both investments cost $7,0

Question

Sun Systems Company has two investment opportunities. Both investments cost $7,000 and will provide the same total future cash inflows. Sun Systems has a required (desired) rate of return of 6%. The cash receipts schedule for each investment is given below:

All other things being equal,

a) investment alternative 1 will produce a higher net present value than alternative 2.

b) investment alternative 2 will produce a higher net present value than alternative 1.

c) both investment opportunities will produce the same net present value.

d) The answer cannot be determined from the information provided.

Sun Systems Company has two investment opportunities. Both investments cost $7,000 and will provide the same total future cash inflows. Sun Systems has a required (desired) rate of return of 6%. The cash receipts schedule for each investment is given below:

Explanation / Answer

NPV1(net present value of alternative 1)=-7000+(2000/1.06)+(2000/1.062)+(2000/1.063)+(5000/1.064)

NPV2(net present value of alternative 2)=-7000+(2000/1.06)+(3000/1.062)+(4000/1.063)+(2000/1.064)

NPV2-NPV1=(1000/1.062)+(2000/1.063)-(3000/1.064)

NPV2-NPV1=(1000/1.062)+(2000/1.063)-(3000/1.064)=(1/1.064)(1000*1.062+2000*1.06-3000) =243.6/1.064=192.95>0

Thus NPV2-NPV1>0=>NPV2>NPV1

Thus investment alternative 2 will produce a higher net present value than alternative 1. option b)

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