Question

An investment is expected to generate the following series of payments over the next several years: $10,000, $8,000, $16,000 and $17,000. The interest rate is 5 percent p.a. The investment is priced at $25,000. How would you figure out whether it is worthwhile investing today?

Select one:

a. You would compute the future value and compare it with the initial investment amount to see if you have made money

b. You would use the present value annuity formula to compute the present value and compare it with the initial investment amount

c. You would work out the present value of each expected payment, add them up and compare the total with the initial investment amount

d. You would add up the expected cash flows and see if they are greater or less than $25,000.

Answer 1

Ans:- To figure out whether it is worthwhile investing today or not:-

we work out the present value of each expected payment, add them up, and compare the total with the initial investment amount. option (c) is the right answer.

Present Value is calculated by Expected Future Value / (1+r)^n, where r is the rate of return and n is the number of years.

In this case, Initial investment is $25,000.

Present Value = $10,000 /(1+0.05)^1+ $8,000/(1+0.05)^2 + $16,000 /(1+0.05)^3 + $17,000 /(1+0.05)^4 = $44.587.39

In this Present Value ($44,587.39) > Initial Investment ($25,000). Therefore it is worthwhile investing today.

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