Scenario: A friend approaches you with four different investment plans that offer you the following returns on an investment of $10,000.
Plan 1: promises a return of $20,000 in 5 years
Plan 2: promises you a return of $5,000 in 2 years and $2,000 in 3 years
Plan 3: promises you a return of $20,000 in 20 years
Plan 4: promises you a return of $15,000 in 10 years
The market rate of interest is 5 percent.
-Refer to the scenario above.The present value of the positive cash flows from the investment in Plan 2 is equal to ________.

Question

Quizplus · Accepted Answer

To calculate the present value of Plan 2, we need to calculate the present value of each cash flow and then add them together. Using the formula for present value:

PV = CF / (1 + r)n

where PV = present value, CF = cash flow, r = market interest rate, and n = number of periods.

For the first cash flow of $5,000 in 2 years, the present value is:

PV = $5,000 / (1 + 0.05)2
PV = $4,535.15

For the second cash flow of $2,000 in 3 years, the present value is:

PV = $2,000 / (1 + 0.05)3
PV = $1,728.39

Adding these together, we get:

PV = $4,535.15 + $1,728.39
PV = $6,263.54

Therefore, the present value of the positive cash flows from Plan 2 is $6,263.54.

The best choice depends on the investor's priorities, goals, and risk tolerance. Plan 1 offers the highest return in the shortest amount of time, but it may also come with higher risk. Plan 2 offers a more consistent return over two different time periods. Plan 3 offers the highest return overall, but requires waiting for 20 years. Plan 4 offers a moderate return in 10 years. Ultimately, the investor should choose the plan that aligns with their goals and risk tolerance.

Scenario: a Friend Approaches You with Four Different Investment Plans