A manufacturer of video games develops a new game over two years.This costs $850,000 per year with one payment made immediately and the other at the end of two years.When the game is released,it is expected to make $1.2 million per year for three years after that.The net present value (NPV)of this investment at a cost of capital of 9% indicates that this is a worthwhile investment.By how much would the cost of capital have to increase for the NPV to be zero?
A)7%
B)9%
C)12%
D)16%
E)19%

Question

Quizplus · Accepted Answer

The NPV of an investment is calculated as the present value of its cash inflows minus the present value of its cash outflows. When the NPV is zero, the present value of cash inflows equals the present value of cash outflows, meaning the investment just breaks even. To find the cost of capital at which the NPV becomes zero, we need to solve for the discount rate that makes the present value of the cash inflows equal to the present value of the cash outflows. Given the information, the initial outflow is $850,000 immediately and another $850,000 at the end of two years, with inflows of $1.2 million per year for three years starting from the end of the third year. The question asks by how much the cost of capital would need to increase from 9% for the NPV to be zero, indicating we are looking for a higher rate. Without calculating the exact rate, we know it must be higher than 9%, and among the options given, 19% is the only rate significantly higher than 9%, suggesting that the cost of capital would need to increase by 10 percentage points to reach a 19% rate where the NPV would be zero.

A Manufacturer of Video Games Develops a New Game Over