2
3.
NPV = -$1,300,000 + ($1,500,000/1.10) = +$63,636
Since the NPV is positive, you would construct the motel.
Alternatively, we can compute r as follows:
r = ($1,500,000/$1,300,000) – 1 = 0.1538 = 15.38%
Since the rate of return is greater than the cost of capital, you would construct the
motel.
4.
Investment
NPV
Return
1)
$5,000
1.20
18,000
10,000
=
+
−
80.0%
0.80
10,000
10,000
18,000
=
=
−
2)
$2,500
1.20
9,000
5,000
=
+
−
80.0%
0.80
5,000
5,000
9,000
=
=
−
3)
$250
1.20
5,700
5,000
−
=
+
−
14.0%
0.14
5,000
5,000
5,700
=
=
−
4)
$1,333.33
1.20
4,000
2,000
=
+
−
100.0%
1.00
2,000
2,000
4,000
=
=
−
a.
Investment 1, because it has the highest NPV.
b.
Investment 1, because it maximizes shareholders’ wealth.
5.
a.
NPV = (-50,000 + 30,000) + (30,000/1.07) = $8,037.38
b.
NPV = (-50,000 + 30,000) + (30,000/1.10) = $7,272.73
Since, in each case, the NPV is higher than the NPV of the office building
($7,143), accept E. Coli’s offer. You can also think of it another way.
The true
opportunity cost of the land is what you could sell it for, i.e., $58,037 (or
$57,273).
At that price, the office building has a negative NPV.
6.
The opportunity cost of capital is the return earned by investing in the best
alternative investment.
This return will not be realized if the investment under
consideration is undertaken.
Thus, the two investments must earn
at least
the
same return.
This return rate is the discount rate used in the net present value
calculation.