Question

Assume you have two investment opportunities that return the following cash flows: Year 1 Year 2 Year 3 Opportunity A $50,000 $50,000 $50,000 Opportunity B $150,000 Assume the opportunity cost rate is positive and the initial cost of the two investments is the same. True or False. You will be indifferent between Opportunity A and Opportunity B because each of the investments return the same total cash flows.

Answer 1

False

Step-by-step explanation:

Year 1 Year 2 Year 3

Opportunity A $50,000 $50,000 $50,000

Opportunity B $150,000

The basic premise of finances is that the value of money changes over time. In other words, one dollar today is worth more than one dollar tomorrow.

Since the discount rate is positive, we can assume 1%, then the present value of the net cash flows for the two projects would be:

Opportunity A = $50,000/1.01 + $50,000/1.01² + $50,000/1.01³ = $49,505 + $49,015 + $48,530 = $147,050

Opportunity B = $150,000/1.01³ = $145,589

So the net present value (NPV) of opportunity A will be higher than the NPV of opportunity B, therefore, the investor should choose opportunity A.