Question

Yani has $12,000 for investment purposes. His bank has offered the following three choices:

Choice 1. A special savings certificate that will pay $120 each month for 5 years and a lump sum payment at the end of 5 years of $13,000
Choice 2. Buy a share of a racehorse for $12,000 that will be worth $27,000 in 5 years
Choice 3. Put the money in a savings account that will have an interest rate of 12% per year compounded monthly

Use an annual worth analysis to make a recommendation to Yani.

What is the annual worth of each choice?

Choice 1, Certificate= 155.29 (incorrect answer)
Choice 2, Racehorse = 807.45 (incorrect answer)

Choice 3, Savings Account= 0 (correct answer)

Answer 1

Answer: Option (C)

Calculating the future value of all 3 choices in the next 5 years.

Choice 1:

FV of cash flow: FV (1%/12,60,-120)
= 13224.24

A lumpsum amount of 13,000 at the end.

Total worth: 13224.24 + 13000 = 26224.24

Annual worth : 26224.24 / 3.1271 = 8386.12

Net gain : 26224 - 12000 = 14224

Annual worth of net gain : 14224 / 3.1271 = 4548.62

Choice 2:

Annual worth : 27000 / 3.1271 = 8634.19

Net gain : 27000 - 12000 = 15000

Annual worth of net gain : 15000 / 3.1271 = 4796.77

Choice 3:

Amount of funds savings account will generate after 5 years: FV (12%/12,60,-12000) = 97382

Net gain : 97382 - 12000 = 85382

Annual worth of net gain - 85382 / 3.1271 = 27303.89

Thus, the option for yani is option (c)