For the given cash flows below, assume the cash flow is the same in the next 2 y

Question

For the given cash flows below, assume the cash flow is the same in the next 2 years. Compute the NPV for each project, and compute the incremental IRR. Compare and explain why NPV always gives the correct decision.

     Project     Initial Investment     Year 1 Cash Flow   
  A             500,000              125,000
B             500,000              120,000

QUESTION: Why should investors who identify positive-NPV trades be skeptical about their findings if they don’t inside information or a competitive advantage? What return should the average investor expect to receive?

Explanation / Answer

Project A

Project B

NPV always gives the correct decission as it considers the discount rate or the rate the company is ready to incur on the investment . It gives the present value of the investment made.

Any investment which has positive net present value will have competetive advantage as the investment made by the company is recoverd with the gain on the investment.

the return investor should the average investor to receive should more than the cost it incurred on the investment.

Year Cash Flow PV Factor = 1/(1+R)^n Present Value = Cash Flow * PV factor 0 ($500,000) 1.000000 ($500,000) 1 $125,000 0.909091 $113,636 2 $125,000 0.826446 $103,306 Sum of Present Value of the Cash Flows $216,942 Less: Amount invested ($500,000) Net Present value = Total PV - Intial Investment ($283,058)

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