Question

If the interest rate is 5%, which of these investments would you prefer?

Multiple Choice A payment of $602 today. A payment of $51 a year for 20 years starting at the end of 1st year. A single payment of $641 at the end of 1st year. An ordinary perpetuity of $30.

Answer 1

We need to find the present value of each multiple-choice.

1) A payment of $51 a year for 20 years starting at the end of 1st year

You need to use a Financial calculator to solve this problem. You can download it.

N = 20 (The payment will be for 20 years)

PMT = -51 ( The payment will be 51 per year)

I/Y = 5 (The interest rate is 5%)

CPT + PV = 635.57

2) A single payment of $641 at the end of 1st year

N = 1 (The payment will be made after 1 year)

I/Y = 5 (The interest rate is 5%)

FV = -641 (641 will be paid after 1 year)

CPT + PV = 610.4761

3)An ordinary perpetuity of $30

Present Value = 30 / Interest Rate

= 30 / 0.05

= 600

After considering all the options, the present value of "A payment of $51 a year for 20 years starting at the end of 1st year" is coming out to be highest, which is 635.57. So you should prefer this.

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