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A firm currently has $5,000 in an account that is earning 3% interest. It is considering using some of this money to invest in a project with the following qualities: Paying out $2650 today buys a machine that increases profit by $500 next year $1000 in two years, $1400 in three years and then completely disintegrates.
a) Calculate the present value of the benefits of this project and use this number to determine if the firm should make the investment. (Note: Not required to show calculations here)
b) Explain whether or not each of the following changes would affect the rate of return of the project described in this problem. If it would change the rate of return, explain whether it would increase or decrease (Do not try to calculate how much). Consider each change separately.
i) The firm does not have $5000 available and the interest rate for borrowing money is 11%.
ii) At the end of 3 years the machine doesn't disintegrate but instead has depreciated so its value is only $600.
iii) The current cost of the project rises to $2750.
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