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A publisher is deciding whether or not to invest in a new printer.The printer would cost $900,and would increase the cash flows in year 1 by $500 and in year 3 by $800.Cash flows do not change in year 2.If the interest rate is 12%
-If the interest rate rises to 25% would the investment still take place?

Question

​Use the following setup for the next question.
A publisher is deciding whether or not to invest in a new printer.The printer would cost $900,and would increase the cash flows in year 1 by $500 and in year 3 by $800.Cash flows do not change in year 2.If the interest rate is 12%
-​If the interest rate rises to 25% would the investment still take place?
A)​Yes since NPV>0
B)No since NPV<0
C)Yes since the present value of the cash flows is greater than zero
D)​No since the present value of the cash flows is lesser than zero

Quizplus · Accepted Answer

To determine if an investment is worthwhile, we need to calculate the net present value (NPV) of the investment. At a 12% interest rate, the NPV of the printer investment is:

NPV = -$900 + $500/(1.12) + $800/(1.12)^3
NPV = -$22.48

Since the NPV is negative, the investment should not be made.

If the interest rate were to increase to 25%, the NPV calculation would be:

NPV = -$900 + $500/(1.25) + $800/(1.25)^3
NPV = -$291.34

This NPV calculation is also negative and is a larger negative value than the prior calculation at the lower interest rate. Therefore, the investment should still not be made. The correct answer is B, No since NPV<0.

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