Suppose an initial investment of $100 will return $50/year for three years (assume the $50 is received each year at the end of the year). Is this a profitable investment if the discount rate is 20%

Since the NPV is positive, it is a profitable investment.

Explanation:

Solution

Given that:

The initial investment of $100 would be considered as an outflow.

The inflow for the next three years will be = $50

The discount rate r = 0.2

To find or determine the probability of the investment, discount the future of outflows and inflows. the following formula is applied or used to find the present value of inflows

PV = FV / (1 + r) ^k

Where

PV = present value

FV = future value

r = discount rate

k = time period

Now,

For k = 1

PV = 50 / (1 + 0.2)

=$41.67

So,

PV for k = 2 is $34.72 and for k = 3 is $28.94

Thus,

The net present value can be calculated by the difference between the outflows and total inflows

NPV = $100 - ($41.67 + $34.72 + $28.94)

=$5.33