Investment opportunity A will require a principal of $1,000 and will yield $200
ID: 2806711 • Letter: I
Question
Investment opportunity A will require a principal of $1,000 and will yield $200 of the course of 4 years. Investment opportunity B will require a principal of $1,600 and will pay $400 over a five year period. Which of the following statements is true?
-Investment A has a higher average annual rate of return than does Investment B. Ignore the time value of money.
-Given this information, the average annual rates of return cannot be computed.
-Investment A has a lower average annual rate of return than does Investment B.
-The average annual rates of return of the two investment opportunities are equal.
Refer to previous question. Suppose that Investment A was a piece of land that you purchased for $1,000 and sold for it $1,200 four years later. Assuming you are in the 35% tax bracket and long term capital gains are taxed at 20%, your net average annual rate of return on investment would be:
-1.75%
-4.25%
-3.25%
-4%
Refer again to question. Suppose that Investment B was a conventional bond that pays $80 yearly. If you held the bond for the entire 5 years, your net average annual rate of return on investment would be?
-3.25%
-1.75%
-4.25%
-4%
Explanation / Answer
a.
Initial investment required in opportunity A is $1,000 and provide $200 cash inflow per year for 4 year. So total cash flow is in 4 year is $800. SO its rate of return must be negative. Again, Initial investment required in opportunity B is $1,600 and provide $400 cash inflow per year for 5 year. So total cash flow is in 5 year is $2,000. SO its rate of return must be [positive.
So, Investment A has a lower average annual rate of return than does Investment B.
Option (C) is correct answer.
b.
Capital Gain = $1,200 - $1,000
= $200
Tax on capital gain = $200 × (1 - 20%)
= $160.
Total percentage capital gain after tax = $160 / $1,000
= 16%.
Annual gain = 16% / 4
= 4%
Annual gain from investment is 4%.
Option (D) is correct answer.
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