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 net present value of the investment in Plan 4 is equal to ________.

Question

Quizplus · Accepted Answer

The net present value (NPV) of an investment is calculated by discounting the future cash flows back to their present value and subtracting the initial investment. For Plan 4, the future cash flow is $15,000 in 10 years. Using a discount rate of 5%, the present value (PV) of this future cash flow is calculated as PV = FV / (1 + r)^n, where FV is the future value, r is the discount rate, and n is the number of periods. Thus, PV = $15,000 / (1 + 0.05)^10 = $15,000 / 1.62889 ≈ $9,209. The initial investment is $10,000, so the NPV = $9,209 - $10,000 = -$791.

Scenario: a Friend Approaches You with Four Different Investment Plans