You are comparing two investment options, each of which will provide $15,000 of
ID: 2731270 • Letter: Y
Question
You are comparing two investment options, each of which will provide $15,000 of total income. Option A pays five annual payments starting with $5,000 the first year followed by four annual payments of $2,500 each. Option B pays five annual payments of $3,000 each. Which one of the following statements is correct given these two investment options? a.) Given a positive rate of return, Option A is worth more today than Option B. b.) Option A is preferable because it is an annuity due. c.) Option B has a higher present value than Option A given a positive rate of return. d.) Both options are of equal value today. e.) Option B has a lower present value than Option A given a zero rate of return.Explanation / Answer
Answer: a.) Given a positive rate of return, Option A is worth more today than Option
Explanations to the above answer
We will select the option A because in option A we will have higher prasent Value then option B
Suppose the interest rate is 5 % and we calculate the NPV the calculation would be as follow
Option A
Year
Cash Flow
Pv factor
Prasent
Value
0
5000
1
5000
1
2500
0.95238
2380.952381
2
2500
0.90703
2267.573696
3
2500
0.86384
2159.593996
4
2500
0.82270
2056.756187
5
2500
0.78353
1958.815416
15823.69168
Option B
Year
Cash Flow
Pv factor
Prasent
Value
0
0
1
0
1
3000
0.95238
2857.142857
2
3000
0.90703
2721.088435
3
3000
0.86384
2591.512796
4
3000
0.82270
2468.107424
5
3000
0.78353
2350.578499
12988.43001
Form the above calculation we could see that option A has higher Value so select Option A
Option A
Year
Cash Flow
Pv factor
Prasent
Value
0
5000
1
5000
1
2500
0.95238
2380.952381
2
2500
0.90703
2267.573696
3
2500
0.86384
2159.593996
4
2500
0.82270
2056.756187
5
2500
0.78353
1958.815416
15823.69168
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