Answer to Question #297371 in Financial Math for Tokyo

Question

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(C) An investor is considering two projects A and B. Project A involves the investment of £1 million at the outset. The only income to be received will be a payment of £3.5 million after ten years. Project B also involves the investment of £1 million at the outset. Income will be received from this project continuously. In the first year the rate of payment will be £0.08 million, in the second year £0.09 million, in the third year £0.10 million, with the rate increasing by £0.01 million each year thereafter until the tenth year, after the end of which no further income will be received.

(a) Calculate the net present value of both investment projects at a rate of interest of 4% per annum effective.

(b) Show that the discounted payback period of project A is after that of project B (no further calculation is necessary).

(c) In the light of your answer to (i) above, explain which project is the more desirable to an investor with unlimited capital, and why.