1. It pays to build the project because at a positive interest rate funds invested grow through time.
2. It just pays to build the project because receipts equal costs.
3. It does not pay to build the project, because the earnings are worth less today than they are in the future.
4. One cannot determine whether the project is profitable without knowing the interest rate.
Choose the correct option.
The correct answer is 3. The rate of interest in the economy is always positive. So the present value of the income from the project must be less than $1200.
Option 2 is incorrect because it assumes that present and future payments can be added together without discounting them. With regard to option 1, it is true that at a positive interest rate funds grow in value through time. But this is why option 3 is correct. A dollar to be received at some point in the future is worth less than a dollar to be received now. Today's dollar will grow to more than a dollar by tomorrow, but tomorrow's dollar will still be worth only a dollar tomorrow and worth less than a dollar today. As for option 4, all we need to know is that the interest rate must be positive.