Calculating which investment option has the higher present value
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%?© SolutionLibrary Inc. solutionlibary.com 9836dcf9d7 https://solutionlibrary.com/business/finance/calculating-which-investment-option-has-the-higher-present-value-29i
$5,000 x 1/1.15^1 = $5,000 X 0.896= $4,347.83
$5,000 x 1/1.15^2 = $5,000 X 0.7561 =$3,780.72
$5,000 x 1/1.15^3 = = $5,000 X.0.6575= $3,287.58
Total present value= $11,416.13
(It would be a great question to do in an Excel spreadsheet!)
So, for the purposes of your question, you want to compare the cash flows of Investment X at 5% to that of Investment Y at 5% than, the cash flows of Investment X at 15% to that of Y at 15%.
(Remember "^" denotes an exponent)
So, you'll have
At a 5% Discount
Investment X ...