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Sample Question about Net Present Value

One of test questions I came across dealing with Net Present Value was the following: If the Net Present Value for each of the cash flows were calculated at a 10% interest rate, the net present value cash flow at the end of five years would be:
a. greater than the total cash flow without the net present value applied
b. Less than the total cash flow without the net present value applied
c. the same as the total cash flow without the net present value applied
d. Unable to be calculated with the information supplied.

The answer is b, but the "without the net present value applied" is throwing me off. Is this added to just clarify the answer?

Here is the table:
End of Year 1, Cash Flow In: 0, Cash Flow Out: 500,000
End of Year 2, Cash Flow In: 300,000, Cash Flow Out: 90,000
End of year 3,Cash Flow In: 400,000, Cash Flow Out: 100,000
End of year 4,Cash Flow In: 100,000, Cash Flow Out: 175,000
End of year 5,Cash Flow In: 50,000, Cash Flow Out: 35,000

Comments

  • 1 Comment sorted by Votes Date Added
  • Hey guys, I figured it out. This question is just not worded in the best way. I reworded it, and based on that, I can see how the answer is b. Here is the re-worded question:

    If the Net Present Value for each of the cash flows were calculated at a 10% interest rate, the total cash flow with the NPV amounts at the end of five years would be:
    a. greater than the total cash flow NOT using the net present value amounts
    b. Less than the total cash flow NOT using the net present value amounts
    c. the same as the total cash flow NOT using the net present value amounts
    d. Unable to be calculated with the information supplied.

    The approach would be to compare the Total Cash Flow with the Total Cash Flow when the NPV amount is considered.
    We do this by a: calculating the NPV for each individual year, then (since we're at the end of Year 5), sum those NPVs. That gives us a Total Cash Flow using NPV values.
    Then b: calculating the Cash Flow for each individual year, then (since we're at the end of Year 5), totaling the Cash flow to get the Total Cash Flow.

    Based on this, the answer is b. The Total Cash Flow using NPV values < Total Cash Flow

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