Question

Joe and Rich are both considering investing in a project that costs $25,500 and is expected to produce cash inflows of $15,800 in Year 1 and $15,300 in Year 2. Joe has a required return of 8.5 percent but Rich demands a return of 12.5 percent. Who, if either, should accept this project?

Answer 1

Answer:

Both Joe and Rich should accept the project.

Explanation:

The investment amount for project = $25500

First year cash inflow (C1) = $15800

Second year cash inflow (C2) = $15300

Interest rate for Joe (r1) = 8.5 percent or 0.085

Interest rate for rich (r2) = 12.5 percent or 0.125

Now we have to find the present value of future inflow and then subtract the initial investment amount.

Net present value in the case of Joe:

Net present value = Present value of cash inflows – initial investment

$\text{ Net present value } = \frac{C1}{(1+ r1)^{n}} + \frac{C2}{(1+ r2)^{n}} – 25500 \\= \frac{15800}{(1+ 0.085)^{1}} + \frac{15300}{(1+ 0.085)^{2}} – 25500 \\= 2058.88 \\\text{ Net present value in the case of rich.} \\\text{ Net present value } = \frac{C1}{(1+ r1)^{n}} + \frac{C2}{(1+ r2)^{n}} – 25500 \\= \frac{15800}{(1+ 0.125)^{1}} + \frac{15300}{(1+ 0.125)^{2}} – 25500 \\= 633.33$

Since the net present value of Joe and Rich is positive so both project should be considered.