Question

A financial advisor offers you two investment opportunities. Both offer a rate of return of 11%. Investment A promises to pay you $450 in 1 year, $650 in 2 years, and $850 in 3 years. Investment B promises to pay you $850 in 1 year, $x in 2 years, and $450 in 3 years. What must x be to make you indifferent between Investing A and B

Answer 1

The value of x is 566.36

Step-by-step explanation:

The value of x should be such that the present value of both Investments is the same when discounted at a rate of 11%. To calculate the present value, we use the following formula,

Present Value = CF 1 / (1+r) + CF 2 / (1+r)^2 + ... + CFn / (1+r)^n

Where,

• CF represents Cash flow
• r represents the discount rate

So, we equate both the present value of Investment A and B to calculate the value of x.

Present Value of A = Present Value of B

450/(1.11) + 650/(1.11)^2 + 850/(1.11)^3 = 850/(1.11) + x/(1.11)^2 + 450/(1.11)^3

1554.472661 = 765.7657658 + x/(1.11)^2 + 329.0361216

1554.472661 - 765.7657658 - 329.0361216 = x/(1.11)^2

459.6707736 * (1.11)^2 = x

x = 566.3603602 rounded off to 566.36