Consider the following cash flow [-100, + 230, -132]. We want to decide under what range of discount rate this is an advantageous investment. But noting the change in sign, we conclude IRR is not a suitable instrument.
- Write the expression for NPV using the unknown r as discount rate.
- Write this expression as a function of [1/(1+r)].
- Show that the expression in (b) as a quadratic equation. Look this up if necessary.
- Solve the quadratic equation for its two roots.
- Prepare a table of NPV vs. r for r= 0,10,20,40,100%.
- Draw the graph of NVP vs. r.
- Under what range of r values is this an acceptable investment?
Noting that NPV increases then declines as r grows from 0 to 40%, determine at what level of r NPV is a maximum (recall that d(NPV)/ds = 0, where NPV is a maximum). If you have sufficient background, solve this using calculus. If not, graphically find the top of the NPV hill (where slope = 0).
What is the maximum value of NPV? (There is one bonus point for the correct answer using calculus).