Question

You are given the option of investing $5,000 now and receiving a payments of $5300 at the end of year 4 and a payment of $5,500 at the end of year 10. The rate of return on your investment would be approximately

Answer 1

12.5%

Step-by-step explanation:

Investment = $5,000

Cash inflow at year 4 = $5,300

Cash inflow at year 10 = $5,500

Rate of return = RR

PV of cash inflows = Investment as on taoiday

5,300 * PVIF(RR,4) + 5,500 * PVIF(RR,10) = 5,000

To get required rate of return, go for trail and error approach

If RR is 10%

L.H.S. = 5,300*PVIF(10%,4) + 5,500*PVIF(10%,10)

= 5,300*0.683+5,500*0.3855

= $2,120.25

If RR = 12.5%

L.H.S = 5,300*PVIF(12.5%,4) + 5,500*PVIF(12.5%,10)

= 5,300*0.6243 + 5,500*0.3079

= 5,002

= $5000

Hence the required rate of return (RR) = 12.5%