C2 - #19, MAY 2001

[Sam (Retired)]

Could anyone teach me how to do the following question?

Consider the following project:
Time 0 1 2 3
Net cash flow -1000.0 240.0 628.4 628.4

Assuming a 20% opportunity cost of capital, the NPV is zero.
Calculate the expected economic income in the second year.

I don't understand the solution says.
Thank you.

[ASA_Woman]

Maybe you should post the solution so that people here will know what you're talking about.

[bg23516]

Economic Income(2) = CF(2) + PV(2) - PV(1)

PV(1) = 628.4v + 628.4v^2 = 960.06
PV(2) = 628.4v = 523.67
CF(2) = 628.4

Plug them in, you get 192.

The confusion probably lies in identifying when everything takes place.

I read this as:
Invest at time 0, get first return at end of year 1. So in year 2, you are waiting on 628.4 at the end of 2, and 628.4 at the end of 3. Find your PV at time 1 as above = 960.06. At the end of the year 2, you have received your 628.4 and are waiting only on the 628.4 at the end of the last year.

HTH.
Marc

[Sam (Retired)]

Thank you for your help. :P