Question

Tanner is choosing between two​ mutually-exclusive investment options. These options have absolutely no​ risk, and Tanner can always borrow and lend at the​ risk-free rate. Option 1. He can invest​ $500 now and get​ (guaranteed) $550 in one year. Option 2. He can invest​ $600 now and get​ (guaranteed) $631.40 back later today. Assume the​ risk-free interest rate is​ 3.5%. Which investment should Tanner​ prefer?

Answer 1

D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.

Step-by-step explanation:

Here are the options to this question:

A) $531.40 later today, since $1 today is worth more than $1 in one year.

B) $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested.

C) Neither - both investments have a negative NPV.

D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.

Net present value is the present value of after tax cash flows from an investment less the amount invested.

NPV can be calculated using a financial calculator:

For the first option:

Cash flow in year 0 = $500

Cash flow in year 1 = $550

I = ​ 3.5%

NPV = $31.40

For the second option:

NPV = $631.40 - $600 = $31.40

The npv of both options are equal and postive. So, Tanner should be indifferent between the options.

To find the NPV using a financial calacutor:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute

I hope my answer helps you