Question

Investment A will pay dividends of $2,700 per year for 5 years, whereas Investment B will pay dividends of $3,500 per year for 7 years. Which of these cash flow streams has the higher present value if the discount rate is 10%? Show your work

Answer 1

In this question, the amounts are received every year. Thus, we need to calculate the present values of the annuity.

For Investment A,

Dividend Received (D) = $2,700

Time(n)= 5 years

Discount Rate(r) = 10%

Present value = D* Present value annuity factor_(10%,5)

Present value = 2,700 * PVAF _(10%,5)

Present value = 2,700 * 3.790778676 = $10,235.12

PVAF values can be checked from the table or calculated as follows:

For Investment B,

Dividend amount(D) = $3,500

Time (n)= 7 years

Discount Rate(r) = 10%

Lets calculate the PVAF first by using the formula:

ie. 4.8684188

Present value = $3,500* 4.8684188 = $17,039.47

Investment B has higher present value of $17,039.47