Question

15-Danny owns two investments, A and B, that have a combined total value of $25,000. Investment A is expected to pay $25,000 in 4 years from today and has an expected return of 13 percent per year. Investment B is expected to pay X in 7 years from today and has an expected return of 8 percent per year. What is X, the cash flow expected from investment B in 7 years from today?

Answer 1

Investment is expected to pay $25,000 4 years from today, having expected return = 13%

Let us compute the present value of Investment A

Present value = Future value / (1 + expected return)^{no of periods}

Present value = $25,000 / (1 + 13%)⁴

Present value = $15,332.97

The amount in Investment A today = $15,332.97

Investment B value today = Today Investment - Amount in Investment A today

Investment B value today = $25,000 - $15,332.97

Investment B value today = $9,668.03

Investment B has a expected return = 8%

Let us compute the value X i.e. Investment B's value, 7 years from today.

Future value = Present value * (1 + expected return)^{no of periods}

Future value = $9,668.03 * (1 + 8%)⁷

Future value = $16,567.59

X = $16,567.59