Question

Investment A costs $6,000 today and pays back $8,000each year for six years. Investment B costs $6,000 today and pays back $9,000 the first year, with a $500 increase annually, making the second year $9,500, third year $10,000 and so forthfor six years. If an interest rate of 10% is used, which alternative is superior?

Answer 1

Answer:

Investment B

Explanation:

In this question we need to compare the net present value which is shown below:

For Investment A, the net present value is  

= -$6,00 + $8,000 ÷ 1.10^1 + $8,000 ÷ 1.10^2 + $8,000 ÷ 1.10^3 + $8,000 ÷ 1.10^4 + $8,000 ÷ 1.10^5 + $8,000 ÷ 1.10^6

= $28,842.09

For investment B, the net present value is

= -$6,000 + $9,000 ÷ 1.10^1 + $9,500 ÷ 1.10^2 + $10,000 ÷ 1.10^3 + $10,500 ÷ 1.10^4 + $110,00 ÷ 1.10^5 + $11500 ÷ 1.10^6

= $38,039.43

As we can see that the investment B has highest net present value as compared to the investment A

Therefore, investment B is superior