Question

1. Consider two investments:
   1. Invest $1000 and receive $110 at the end of each month for the next 10 months.
   2. Invest $1200 and receives $130 at the end of each month for the next 10 months.

If this were your money, and you want to earn at least 12% interest on your money, which investment would you make, if any? What nominal interest rate do you earn on each investment?

(show all equations)

Answer 1

Present value = cash flow / (1 + required return per month)^{number of months}

Here, the required return per month = 12% / 12 = 1%

First investment

Present value = (110 / 1.01¹) + (110 / 1.01²) + (110 / 1.01³) + ...........+ (110 / 1.01¹⁰)

Present value = $1,041.84

Net present value = present value - initial investment = $1,041.84 - $1,000 = $41.84

Second investment

Present value = (130 / 1.01¹) + (130 / 1.01²) + (130 / 1.01³) + ...........+ (130 / 1.01¹⁰)

Present value = $1,231.27

Net present value = present value - initial investment = $1,231.27 - $1,200 = $31.27

I would make the first investment as its net present value is higher

Nominal return earned on each investment is calculated using IRR function in Excel