P 5-36 (similar to) Question Help You are thinking about investing $5,125 in you
ID: 2794833 • Letter: P
Question
P 5-36 (similar to) Question Help You are thinking about investing $5,125 in your friend's landscaping business. Even though you know the investment is risky and you can't be sure, you expect your investment to be worth $5,630 next year. You notice that the rate for one-year Treasury bills is 1%. However, you feel that other investments of equal risk to your friend's landscape business offer an expected return of 11% for the year. What should you do? The present value of the return is $. (Round to the nearest cent.)Explanation / Answer
Given -
Current Investment = $5,125
Expected Investment next year = $5,630
Rate of one-year Tresury Bills = Risk-free rate = 1%
Expected rate of return on equivalent risk component investment = 11%
To Find -
1. Present Value of the return in $ ?
2. Decision ?
1. Calculation of Present Value of the return in $
Formula -
PV = FV / (1 + r)n
where,
PV = Present Value
FV = Future Value
r = rate of return
n = number of years
Calculation -
Substituting values in the above formula we get,
PV = $5,630 / (1 + 0.11)1
= $5,630 / (1.11)1
= $5,630 / 1.11
= $5,072.07
PV = $5,072 (rounded off)
Present Value of the return is $5,072
2. Decision :
Future Value of the return if invested in equal risk investment of friend's landscape business
Formula -
Future Value (FV) = Present Value (PV) + (1 + rate of return)n = number of years
Calculation -
Substituting the values in the above formula we get ,
= $5,125 x (1 + 0.11)1
= $5,125 x (1.11)1
= $5,125 x 1.11
FV = $5,688.75
Decision -
The expected return on investment in friend's lanscape business is $5.630 whereas in investment of same risk has expected return of $ 5,688.75. So, investment in equal risk to that of friend's landscape business has comparatively higher return and should be chosen to invest.
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