Question

You are considering between 2 investments: A and B. Investment A will pay you $100 per year forever with the first cash flow occurring 11 years from today. Investment B will pay you $90 per year forever with the first cash flow also occurring 11 years from today; however, the cash flow amounts are expected to grow at 1% forever. Assume interest rates are expected to be 6.125% every year forever

1. What is investment A worth today

2. What is investment B worth today

Answer 1

value of investment can be calculated using the following steps:-

Step1

Investment value at the end of 10th year can be calculated using the following formula:-

= Income for 11th year/(required return-growth rate)

Step 2

Now I have to find the present value of investment value found in step 1

Worth of investment A

Step 1

= 100/( 0.06125-0.01)

= 1951.22

Step 2

Discounted value for 10 year = 1951.22/(1.06125)10

= 1076.79

Investment A worth today= 1076.79

Worth worth of investment B

step1

= 90/(0.06125-.01)

= 1756.01

step 2

Discounted discounted value of 10 year

=1756.01/1.06125¹⁰

=969.06

Investment B worth today = 969.06