You are considering two investment options. In option A, you have to invest $3,0

Question

You are considering two investment options. In option A, you have to invest $3,000 now and $2,000 exactly 4 years from now. In option B, you have to invest $3000 now, $1100 one year from now, and $2,000 exactly 4 years from now. In both options, you will receive 5 annual payments of $2,000 each. (You will get the first payment exactly one year from now.) If the interest rate is 9% compounded annually, what is the net present value of your preferred investment option? If you decide neither option is good, enter 0.

Explanation / Answer

Present value of Annual cash inflows for 5 years ($ 2000 for Annuity of 9% for 5 yrs i.e.3.89) 7780 (Same for both the options Option -1 $ 3000 invest now and $ 2000 after 4 years) Presetn value of outflow for $ 3000 3000 Present value of outflow to be invested after 4 years( 2000*PV factor of 4th yeari.e 0.708) 1416 Total Presetn value of outflow 4416 Net Present value 3364 Present value of Annual cash inflows for 5 years ($ 2000 for Annuity of 9% for 5 yrs i.e.3.89) 7780 (Same for both the options Option -2 $ 3000 invest now, $ 1100 from one year and $ 2000 after 4 years) Presetn value of outflow for $ 3000 3000 Present value of outflow to be invested after one year(1100 *PV factor of 1st year i.e. 0.917) 1008.7 Present value of outflow to be invested after 4 years( 2000*PV factor of 4th yeari.e 0.708) 1416 Total Presetn value of outflow 5424.7 Net Present value 2355.3 Therefore, Net present value of investment under Option -1 is better. Option 1 is better investment.

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