Question

You can invest your money in either investment ONE or investment TWO. You will invest for 2 years. Investment ONE yields 6% he first year and 65% the second year. Investment TWO yields 65% the first year and 6% the second year. Interest is compounded the same for both investments. Also, interest is compounded the same for both years. Which investment leads to the higher return?
a. investment ONE
b. investment TWO
c. the return on investment ONE = the return on investment TWO
d. you do not have enough information, you must know what the cash flows are

Answer 1

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Correct Answer: Option C) The return on investment ONE = the return on investment TWO

Reasoning:

Let us understand this problem by creating a hypothetical investment of 100 $ and investing the same in either option.

• Investment ONE :

Investment after two years = Initial investment * (1+ yield for the first year) * (1+ yield for the second year)

Substituting the values,

Investment after two years = 100 * (1+ 0.06) * (1+ 0.65)

Investment after two years = 100 * (1.06) * (1.65)

Investment after two years = 100 * (1.06) * (1.65) = Dollar 174.9

• Similarly for Investment TWO :

Investment after two years = Initial investment * (1+ yield for the first year) * (1+ yield for the second year)

Substituting the values,

Investment after two years = 100 * (1+ 0.65) * (1+ 0.06)

Investment after two years = 100 * (1.65) * (1.06)

Investment after two years = 100 * (1.06) * (1.65) = Dollar 174.9

In both, the scenario returns are identical as 74.9 % as the investment appreciates to Dollar 174.9 from dollar 100.

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