Investment options A and B are equally risky and have identical initial costs. E

Question

Investment options A and B are equally risky and have identical initial costs. Each investment will produce cash inflows of $20,000. Option A will pay $8,000 the first year followed by four annual payments of $3,000 each. Option B will pay five annual payments, starting in 1 year, of $4,000 each. Which one of the following statements is correct given these two investment options? Assume a positive rate of return.

Select one:

A. Option B has a higher net present value.

B. Neither investment should be undertaken.

C. Option A is the better investment.

D. Both options are of equal value.

E. Option B has a lower future value at Year 5.

Explanation / Answer

Answer > C. Option A is the better investment.

Advantage attached with Option A:

1.       The payback period will be early

2.       The higher ($8000) and early cash flow in year 1 will throw a higher NPV than project B

3.       If we apply same discounting value for both the options we would get higher NPV for option A hence option A is better investment

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