Explore BrainMass

Explore BrainMass

    Calculating which investment option has the higher present value

    Not what you're looking for? Search our solutions OR ask your own Custom question.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    Investment X offers to pay you $2,000 per year for 10 years, whereas Investment Y offers to pay you $4,000 per year for 4 years. Which of these cash flow streams has the higher present value if the discount rate is 5%? If the discount rate is 15%?

    © BrainMass Inc. brainmass.com October 1, 2022, 6:10 pm ad1c9bdddf

    Solution Preview

    Refer to the attachment for the complete solution.

    There are two ways you could go about this problem:

    1) you could discount back one period at a time, or
    2) you could calculate the present values individually and then add them up.

    For purposes of illustration, I'll demonstrate calculating the present values than adding them all up.

    Remember - the present value of a cash flow is the future value multiple by 1/1+Discount Rate.

    Let's say for example you had investment Z, this investment will give you 3 payments of 5,000 for 3 years. Let's assume the discount rate 15%.

    The cash flows would be as ...

    Solution Summary

    The solution presents very clear instructions for how to calculate the present value of a future stream of payments. Two methods are mentioned; one is demonstrated. Then the set up for the problems in this posting are done and explained.