Analyzing in another problem, the possible construction of an office building on a plot of land appraised at $50,000. We concluded that this investment had a positive NPV of $5,000 at a discount rate of 12 percent.
Suppose E. Coli Associates, a firm of genetic engineers, offers to purchase the land for $58,000, $20,000 paid immediately and $38,000 after one year. U.S. government securities maturing in one year yield 5 percent.
a) Assume E. Coli is sure to pay the second $38000 installment. Should you take its offer or start on the office building? Explain.
b)Suppose you are not sure E. Coli will pay. You observe that other investors demand a 10 percent return on their loans to E. Coli. Assume that the other investors have correctly assessed the risks that E. Coli will not be able to pay. Should you accept E. Coli's offer?
a) NPV under situation A is = -50000 + 20000 + 38000/1.05 = 6190.47619
Since NPV under this option is more ...
This solution shows step-by-step calculations to determine the net present value under situations of A and B.