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An investor is deciding between two projects, both of which have an initial cost of £5,000. One project will return £10,000 in three years with a 5% discount rate and the other project will return £9,500 in two years with a 3% discount rate. The investor determines the first project is worth £8,638 today, whereas the second project is worth £8,955 today, and he determines to invest in the second project. In deciding between the projects, the investor is most likely using the:

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Answer:

The answer is: The net present value of the investments

Explanation:

The net present value calculates the current monetary value of a project's future cash flows, using a discount rate. You must remember that $1 today is worth more $1 in the future.

When deciding what projects should be financed, an investor will always look for projects with a NPV ≥ 0, and if he has to decide between two projects, the he will probably choose the project with the highest NPV.

The easiest way to calculate the net present value is to use an excel spreadsheet and the NPV function:

=NPV(rate,value 1, value 2,... value n)

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