Final answer:
The NPV for Project B can be calculated by discounting each of the project's future cash flows back to their present value using the specified interest rate of 15%, and then subtracting the initial investment. This calculation allows the investor to understand the profitability of the investment after taking the time value of money into account.
Step-by-step explanation:
When evaluating projects using the Net Present Value (NPV) method, we are essentially comparing the present value of cash inflows to the initial investment. To find the NPV for Project B, we will discount each future cash flow back to its present value using the formula PV = FV / (1 + r)^n, where PV is the present value, FV is the future value of the cash flow, 'r' is the discount rate (15% in this case), and 'n' is the number of periods until the cash flow occurs.
-
- For Year 1: PV = 3 / (1 + 0.15)^1
-
- For Year 2: PV = 4 / (1 + 0.15)^2
-
- For Year 3: PV = 5 / (1 + 0.15)^3
-
- For Year 4: PV = 6 / (1 + 0.15)^4
-
- For Year 5: PV = 7 / (1 + 0.15)^5
Then, sum up all these present values and subtract the initial investment to get the NPV of Project B.
The calculation would look something like this:
NPV = Σ (Cash Flow in Year t / (1 + r)^t) - Initial Investment
Where Σ (Sigma) denotes the sum of the present values calculated for each year. Plug in the numbers, and you get your NPV for Project B. This helps investors to assess the profitability of an investment considering time value of money and is crucial for making informed investment decisions.