Investment Decision: Buy or Pass?
Should I buy Investment B based on the given data?
Given the return and initial investment amount, should I make the investment decision to buy Investment B?
Answer:
The statement is true. When discounting the future cash flows back to present value using a 16% annual interest rate, the total present value of the cash flows is more than the purchase price of the investment. Therefore, it would be a sound decision to buy the investment.
Investment B offers returns of $16000 in year 1, $15000 in year 2, $12000 in year 3, and $10000 in year 4. The initial investment amount is $26500, with a required Annual Percentage Rate (APR) of 16%. To determine whether it is advisable to buy Investment B, we need to calculate the present value of the future cash flows and compare it with the purchase price.
To calculate the present value of each year's return, we discount the cash flows back to the present using the annual interest rate of 16%. The calculations are as follows:
- Year 1: $16000 / (1 + 0.16)^1 = $13793.10
- Year 2: $15000 / (1 + 0.16)^2 = $11132.33
- Year 3: $12000 / (1 + 0.16)^3 = $7729.15
- Year 4: $10000 / (1 + 0.16)^4 = $5479.46
Adding these present values together results in a total present value of $37734.04. Since the present value of the future cash flows exceeds the purchase price of $26500, the recommendation is to buy Investment B.
By analyzing the data and discounting the cash flows to their present value, we can determine whether an investment decision is financially sound. In this case, the calculations show that acquiring Investment B aligns with your financial goals and the expected return on investment.
Remember, always evaluate investments based on their potential returns and risks to make informed decisions for your financial future.