Final answer:
The question involves calculating the rate of return on an investment with a known initial deposit and a series of annual cash flows. A stated expected rate of return of 13.07% suggests the IRR calculation has been made. Compound interest plays a crucial role in such financial calculations.
Step-by-step explanation:
The question asks to calculate the rate of return expected from an investment where $25,200 is invested today and cash flows of $3,700 are received at the end of each year for the next 18 years. To find the rate of return, one would typically use a financial calculator or software to compute the internal rate of return (IRR) for these cash flows. However, since the question states an expected rate of return as 13.07%, this implies that the investment's IRR has been calculated or given as approximately 13.07%. This percentage reflects the compounded annual growth rate of the investment, assuming all cash flows occur at regular intervals and are reinvested at the same rate.
Understanding the concept of compound interest is essential here, as it is the interest calculated on the initial principal and also on the accumulated interest of previous periods. A well-diversified stock portfolio, for example, could be assumed to have a 7% real annual rate of return above the rate of inflation, as illustrated by the compound interest formula applied on a $3,000 initial investment over 40 years.