Question

You are trying to choose between two investments. Everything about them is the same except that...

You are trying to choose between two investments. Everything about them is the same except that Investment A has payments that begin today and Investment B has payments that begin in 1 year. Which of the following is true? a. Choose investment A because it is worth more. b. Choose investment B because it is worth more. c. You are indifferent between the two investments.

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Answer #1

The correct option is A.

This is because future value of annuity due/present value of annuity due is higher than the future value of annuity/present value of annuity.

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

while

Present value of annuity due=(1+interest rate)*Annuity[1-(1+interest rate)^-time period]/rate

Also:

Future value of annuity=Annuity[(1+rate)^time period-1]/rate

while

Future value of annuity due=(1+interest rate)*Annuity[(1+rate)^time period-1]/rate

Hence interest factor adds up to give higher value to A as compared to B.

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