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A lifestyle investment company has the following two options: The first investment option, which costs $65,000,...

A lifestyle investment company has the following two options: The first investment option, which costs $65,000, is a perpetuity and pays $10,000 a year (in perpetuity) from year 3 onwards. The second investment costs $60,000 and pays the following cash flows in years 2 to 7: Yr 2: $15,000, Yr 3: $16,000, Yr 4: $17,000, Yr 5: $18,000, Yr 6: $19,000 and Yr 7: $20,000. Identify, for your client, which of these investments are good investments, assuming that the rate of return on investment is 13% p.a. for your client.

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Answer #1

For that we need to find the npv for both investments:

OPTION 1:

NPV = C3/[r(1 + r)3] - C0

= $10,000/[0.13(1.13)3] - $65,000

= $53,311.55 - $65,000 = -$11,688.45

OPTION 2:

NPV = C2/(1 + r)2 + C3/(1 + r)3 + C4/(1 + r)4 + C5/(1 + r)5 + C6/(1 + r)6 + C7/(1 + r)7 - C0

= $15,000/1.132 + $16,000/1.133 + $17,000/1.134 + $18,000/1.135 + $19,000/1.136 +

$20,000/1.137 - $60,000

= $11,747.20 + $11,088.80 + $10,426.42 + $9,769.68 + $9,126.05 + $8,501.21 - $60,000

= $659.36

Option 2 is the better investment.

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