Typically, in order to determine the best investment amongst the competing investment, we will need to compute the present value of each investment. The investment with higher present value shall be chosen over the other investment.
In this case, the discounting factor is 14%. Given that the cash flow occur at the end of each year, we will have to use the cash flow with appropriate discount factor at the end of each year. We will have to use the "present value of $1 table" to arrive at the present value of cash flows of investment A and B. Take the present value factor @14% from the table.
The detailed working is summarised in the below table:
in $ | |||||
Year | Investment | Discounting Factor @14% | Present value | ||
A | B | Investment A | Investment B | ||
a | b | c | d | e=b*d | f=c*d |
1 | 6,000 | 6,000 | 0.877 | 5,262 | 5,262 |
2 | 5,000 | 6,000 | 0.769 | 3,845 | 4,614 |
3 | 7,000 | 6,000 | 0.679 | 4,753 | 4,074 |
Total | 18,000 | 18,000 | 13,860 | 13,950 |
Answer
The present value of investment opportunity A is $ 13,860 and B is $13,950.
Investment opportunity B should be chosen because the present value of cash flows in investment B is higher than the present value of investment opportunity in A
annual cash flows Annual cash flows from two competing investment opportunities are given. Each investment opportunity...
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