Answer:
Since the NPV is positive, it is a profitable investment.
Explanation:
Solution
Given that:
The initial investment of $100 would be considered as an outflow.
The inflow for the next three years will be =$50
The discount rate r = 0.2
To find or determine the probability of the investment, discount the future of outflows and inflows. the following formula is applied or used to find the present value of inflows
PV = FV/(1 + r )^k
Where
PV = present value
FV =future value
r = discount rate
k = time period
Now,
For k =1
PV = 50/(1 + 0.2)
=$41.67
So,
PV for k = 2 is $34.72 and for k =3 is $28.94
Thus,
The net present value can be calculated by the difference between the outflows and total inflows
NPV =$100- ($41.67 + $34.72 + $28.94)
=$5.33
It is a profitable investment with a positive NPV at a discount rate of 20%.
Data and Calculations:
Initial investment = $100
Annual cash inflows = $50
Period of investment = 3 years
Discount rate = 20%
Present Value (PV) annuity factor for 3 years at 20% = 2.106
Present value of annual cash inflows = $105.3 ($50 x 2.106)
Net Present Value (NPV) = $5.3 ($105.3 - $100)
Thus, with a positive NPV, it shows that the investment is profitable.
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