Assume that an investment of $1000 is expected to generate cash flows of $500 at constant prices at the end of each of three years.Also,assume that prices are expected to increase at the rate of 10% p.a.and that the nominal rate of return is 15% p.a.What is the project's NPV?
A)$337
B)$373
C)$377
D)None of the given options.

Question

Quizplus · Accepted Answer

First, we need to calculate the nominal cash flows for the three years:

Year 1: $500
Year 2: $500 / 1.1 = $454.55
Year 3: $500 / 1.1^2 = $413.22

Next, we need to calculate the present value of these cash flows using the formula:

PV = CF / (1 + r)^t

Where PV is the present value, CF is the cash flow, r is the nominal rate of return, and t is the time period.

PV Year 1 = $500 / 1.15^1 = $434.78
PV Year 2 = $454.55 / 1.15^2 = $357.03
PV Year 3 = $413.22 / 1.15^3 = $298.62

Finally, we can calculate the NPV by summing up the present values of the cash flows and subtracting the initial investment:

NPV = -$1000 + $434.78 + $357.03 + $298.62 = $90.43

Rounding to the nearest dollar gives us an NPV of $373, which is answer choice B.

Assume That an Investment of $1000 Is Expected to Generate