You are comparing two investment options. The cost to invest in either option is

Question

You are comparing two investment options. The cost to invest in either option is the same today. Both options will provide you with $20,000 of income. Option A pays five annual payments starting with $8,000 the first year followed by four annual payments of $3,000 each. Option B pays five annual payments of $4,000 each. Which one of the following statements is correct given these two investment options? Hint: This is tricky.

A)Option A is preferable because it is an annuity due.

B)Option B has a higher present value than option A given a positive rate of return.

C)Option A is the better choice of the two given any positive rate of return.

D)Option B has a lower future value at year 5 than option A given a zero rate of return.

E)Both options are of equal value given that they both provide $20,000 of income.

Explanation / Answer

Option C is correct beacuse AT RATE >0% Option a is better because it givere higher NPV at rate greater than 0.

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A B C D E 1 Year 0 1 2 3 4 2 Option A 8000 3000 3000 3000 3000 3 Option B 4000 4000 4000 4000 4000 4 Incremental cash Flow 4000 -1000 -1000 -1000 -1000 IRR 0% Using excel formula =IRR(A4:E4)

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