Question

Consider two investment opportunities. The first promises to make fixed quarterly payments of $1200 for 20...

Consider two investment opportunities. The first promises to make fixed quarterly payments of $1200 for 20 years, but the payments do not start until 4 years from now. The second promises to make fixed annual payments of $6000 forever, but the payments do not start until 8 years from now. If the required return for both is 8%, which one do you prefer? How much would you be willing to pay for each of these investments?

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Answer #1

Value of investment after 4 year is calculated in excel and screen shot provided below:

Value of investment after 4 year is $47,693.42.

Present value Now = $47,693.42 / (1 + 8%) ^ 4

= $47,693.42 / 1.3605

= $35,056.08.

Present value Now of first investment is $35,056.08.

Now,

Value of second investment after 8 year = $6,000 / 8%

= $75,000

Value of second investment after 8 year is $75,000.

present value now = $75,000 / (1 + 8%) ^ 8

= $75,000 / 1.8509

= $40,520.17.

present value of second investment is $40,520.17.

Since, Present value of second investment is higher than present value of first investment. So you should invest in second investment.

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