Mutually exclusive investments and risk Personal Finance Problem Lara Fredericks
ID: 2818211 • Letter: M
Question
Mutually exclusive investments and risk Personal Finance Problem Lara Fredericks is interested in two mutually exclusive investments. Both investments cover the same time horizon of 5 years. The cost of the first investment is $9,700, and Lara expects equal and consecutive year-end payments of $3,100. The second investment promises equal and consecutive payments of $4,500 with an initial outlay of $11,900 required. The current required return on the first investment is 8.5% and the second carries a required return of 10.5% a. What is the net present value of the first investment? b. What is the net present value of the second investment? c. Being mutually exclusive, which investment should Lara choose? d. Which investment is relatively more risky? Explain a. The net present value for project one is S. (Round to the nearest cent.)Explanation / Answer
a.
NPV = $2,515.99
Discount rate = R =
8.50%
Present Values (PV)
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$9,700.00
1.000000
(9,700.0000)
1
$3,100.00
0.921659
2,857.1429
2
$3,100.00
0.849455
2,633.3114
3
$3,100.00
0.782908
2,427.0151
4
$3,100.00
0.721574
2,236.8803
5
$3,100.00
0.665045
2,061.6408
Total of PV = NPV =
$2,515.99
b.
NPV = $4,942.86
Discount rate = R =
10.50%
Present Values (PV)
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$11,900.00
1.000000
(11,900.0000)
1
$4,500.00
0.904977
4,072.3982
2
$4,500.00
0.818984
3,685.4282
3
$4,500.00
0.741162
3,335.2292
4
$4,500.00
0.670735
3,018.3069
5
$4,500.00
0.607000
2,731.4995
Total of PV = NPV =
$4,942.86
c.
The second project should be selected because it has high rewards, IRR is higher as cash flows are higher in ratio than first project
d.
Second investment is more risky because it has higher project cost or required rate of return. Returns are higher of risk projects.
Discount rate = R =
8.50%
Present Values (PV)
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$9,700.00
1.000000
(9,700.0000)
1
$3,100.00
0.921659
2,857.1429
2
$3,100.00
0.849455
2,633.3114
3
$3,100.00
0.782908
2,427.0151
4
$3,100.00
0.721574
2,236.8803
5
$3,100.00
0.665045
2,061.6408
Total of PV = NPV =
$2,515.99
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