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investment a costs $10,000 today and pays back $11,500 two years from now. investment b costs $8000 today and pays back $4500 each year for two years. if an interest rate of 5% is used, which alternative is superior?



Answer :

If an interest rate of 5% is used, then investment A is superior.

Define interest rate.

A rate of interest tells you how expensive borrowing is or how advantageous saving is. Therefore, if you are a borrower, the interest rate is the cost of borrowing money and is stated as a percentage of the total loan amount.

The real interest rate accounts for inflation by calculating the rise in the loan's real value plus interest. The repayment of principal and interest is computed in real terms by comparing the amount to its purchasing power at the time it was borrowed, lent, deposited, or invested.

To find the NPV of two investments

NPV (A) = -10000 + 11500 (P/F, 5%, 2)

= -10000 + 11500*0.90703

= 431

NPV (B) = -8000 + 4500(P/A, 5%, 2)

= -8000 + 4500*1.8594

= 367

Since NPV (A) > NPV (B)

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