Q1 (a) You have $1,000 and are given the choice of two investments. The first in

Question

Q1

(a) You have $1,000 and are given the choice of two investments. The first

investment returns $1,500 to you 3 in three years time. The second investment

returns $3,000 in ten years. Assuming a discount rate of 5% p.a., which

investment do you choose?

(b) You have the choice of two income streams. The first involves receiving $2,000

immediately. The second involves receiving $1,000 in one year and $1,500 in two

years. Assuming a discount rate of 8% p.a., which income stream do you choose?

(c) You have the choice of two income streams. The first involves receiving $3,000 in

three years and the second involves receiving $3,500 in four years. At what

discount rate are you indifferent between these two income streams? (Hint: find

the discount rate that makes the present value of these two income streams

equal.)

Explanation / Answer

1), for first investment we have

1500=1000(1+r)^3

or

r=14.47%

for the 2nd investment

3000=1000(1+r)^10

so r= 11.6 %

so the first investment is better option.

2).PV for the 1st income= 2000(1.08)^2

=2332.8

and for the second stream 1000*1.08+1500

=2580

so second option is better

c).equationg pV for both of these we get

3000(1+1/1+r + 1/(1+r)^2)= 3500(1+1/1+r+1/(1+r)^2+1/(1+r)^3)

so on solving we get r=

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