Assume you have $12,000 in cash. You can deposit it today in a mutual fund earni

Question

Assume you have $12,000 in cash. You can deposit it today in a mutual fund earning 8.2% semiannually, or you can wait, enjoy some of it, and invest $11,000 in your brother's business in two years. Your brother is promising you a return of at least 10% on your investment. Regardless of the investment option you choose, you will have to cash in at the end of 10 years. Assume your brother is trustworthy and that both investments carry the same risk. Which investment option will you choose and why? Justify your answer using time value of money calculations and concepts.

Explanation / Answer

Answer) Upon analysis of both the investments,

Invest 1 returns at the end of 10th year would be:-

FV = PV *(1+R)^2n

Where, FV is the future value , PV is the present value and R is the rate of return and n is the years till maturity

FV = 12000 * (1+0.082)^2*10 = 58039.87

Invest 2 returns at the end of 10th year

FV = 11000*(1+0.10)^10 = 28531.17

Hence it is clear that return from investment 1 in mutual funds is greater as compared to investment in brothers business. It is because the return offered by mutual fund is a semiannual rate that means the compounding periods in the investment horizons are more. Hence the return in case 1 is more.

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