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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 is 25%,but cash flows change such that the investment renders a cash flow of $500 in year 1 and $800 in year 2 instead of year 3,would the investment 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 is 25%,but cash flows change such that the investment renders a cash flow of $500 in year 1 and $800 in year 2 instead of year 3,would the investment 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

At an interest rate of 12%, the cash flows can be discounted as follows:
Year 0: -900
Year 1: 500/(1.12) = $446.43
Year 2: 0
Year 3: 800/(1.12)^3 = $549.59

NPV = -900 + 446.43 + 549.59 = $96.02
NPV is positive, so the investment would take place.

At an interest rate of 25%, the cash flows would be:
Year 0: -900
Year 1: 500/(1.25) = $400
Year 2: 800/(1.25)^2 = $512

NPV = -900 + 400 + 512 = $12
NPV is positive at 25%, but the cash flows have been rearranged. Since the cash flows are not the same as before, we cannot directly compare the NPV at 12% and 25%. However, since the NPV is much lower at 25%, it is unlikely that the investment would take place at the higher interest rate. Therefore, the best answer is B.

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