Bob Davies must decide whether to invest $100,000 in his own business or in anot
ID: 2486132 • Letter: B
Question
Bob Davies must decide whether to invest $100,000 in his own business or in another local business. Both investment projects have an expected life of 5 years. The cash flow of each is as follows:
Year 1- Davies $20,000 Other $10,000
Year 2- Davies $30,000 Other $10,000
Year 3- Davies $40,000 Other $30,000
Year 4- Davies $10,000 Other $40,000
Year 5- Davies $5,000 Other $50,000
Suppose the risk of the projects is the same and is accounted for by a risk premium of 6% per year.
Would either investment make sense?
Which would be better?
Explanation / Answer
NPV OF INVESTING IN OWN BUSINESS
NPV OF INVESTING IN OTHER BUSINESS
INVESTING IN OTHER BUSINESS MAKE SENSE BECAUSE IT HAS A POSITIVE NPV.
INVESTING IN OTHER BUSINESS IS BETTER, AS IT HAS A POSITIVE NPV
YEAR CASH FLOW DISCOUNTING FACTOR DISCOUNTED CASH FLOW 0 ($100000) 1.000 ($100000) 1 $20000 0.9434 $18868 2 $30000 0.8899 $26697 3 $40000 0.8396 $33584 4 $10000 0.7921 $7921 5 $5000 0.7473 $3737 NPV ($9193)