As manager of short-term projects, you are trying to decide whether or not to invest in a short-term project that pays one cash flow of $1,000 one year from today. The total cost of the project is $950. Your alternative investment is to deposit the money in a one-year bank Certificate of Deposit which will pay 4% compounded annually.
a. Assuming the cash flow of $1,000 is guaranteed (there is no risk you will not receive it) what would be a logical discount rate to use to determine the present value of the cash flows of the project?
b. What is the present value of the project if you discount the cash flow at 4% per year? What is the net present value of that investment? Should you invest in the project?
c. What would you do if the bank increases its quoted rate on one-year CDs to 5.5%?
d. At what bank one-year CD rate would you be indifferent between the two investments?
a. Because alternative investments are earning 4%, a logical choice would be to discount the project's cash flows at 4%. This is because 4% can be considered as your opportunity cost for taking the project; hence, it is ...
The solution is comprised of an explanation of investment decisions and the factors which affect them.