Question

A firm must choose between two investment alternatives, each costing $100,000. The first alternative generates $35,000 a year for four years. The second pays one large lump sum of $160,300 at the end of the fourth year. If the firm can raise the required funds to make the investment at an annual cost of 9 percent, what are the present values of two investment alternatives? Use Appendix B and Appendix D to answer the question. Round your answers to the nearest dollar.

PV(First alternative): $
PV (Second alternative): $
Which alternative should be preferred?
The -Select- alternative should be preferred.

Answer 1

The present value of the two investment alternatives is calculated using the Present Value of Annuity and Present Value of a Single Amount formulas. The present value of the second alternative is slightly higher, so it should be preferred over the first alternative.

Step-by-step explanation:

To calculate the present values of the two investment alternatives, we need to find the present value of the cash flows for each alternative. The first alternative generates $35,000 a year for four years. Using the Present Value of Annuity formula, with a 9% discount rate, we can calculate that the present value of this alternative is approximately $109,136.28. The second alternative pays a lump sum of $160,300 at the end of the fourth year. Using the Present Value of a Single Amount formula, the present value of this alternative is approximately $109,607.88.

As the present value of the second alternative is slightly higher, it should be preferred over the first alternative. This means that the firm should choose to receive the lump sum of $160,300 at the end of the fourth year rather than the $35,000 per year for four years.