You are offered a chance to buy an asset for $7,250 that is expected to produce cash flows of $750 at the end of Year 1, $1,000 at the end of Year 2, $850 at the end of Year 3, and $6,250 at the end of Year 4.What rate of return would you earn if you bought this asset?
A) 4.93%
B) 5.19%
C) 5.46%
D) 5.75%
E) 6.05%

Question

Quizplus · Accepted Answer

The rate of return can be calculated using the Net Present Value (NPV) formula set to zero, because the NPV of investing in the asset should equal the cost of the investment for the investor to earn the expected rate of return. The cash flows are discounted back at the rate of return to find the present value, which should equal the investment cost of $7,250. The correct rate of return is the one that makes the NPV equal to zero. Through financial calculation or using a financial calculator, the rate that fits this criterion is 6.05%.

You Are Offered a Chance to Buy an Asset for $7,250