Question

As the Fund Manager for Bank of Trinidad and Tobago Limited, you are to advise the following
two (2) clients based on their respective financial situations.

a. Your best friend has asked to assist him in making the best investment out of the following
options. Which would you advise him to choose and why, considering the risks are the same for all
the options. Show all workings to support your answer.

Option 1: $12,000 in 5 years at 6 percent interest.

Option 2: $15,000 in 2 years at 9 percent
interest.

Option 3: $15,000 today. No strings attached.
Option4: $5,000 each year for 2 years at 7 percent interest compounded
semiannually.   
  

Answer 1

Answer:

Option 1:
Future Value = $12,000
Rate (r ) = 6%
Time (n ) = 5 years

Present Value = Future Value / (1 + r)^ n
Present Value = $12,000 / (1 + 0.06)^5
Present Value = $12,000 / 1.06^5
Present Value = $12,000 / 1.3382
Present Value = $8,967.27

Option 2:
Future Value = $15,000
Rate (r ) = 9%
Time (n ) = 2 years

Present Value = Future Value / (1 + r)^ n
Present Value = $15,000 / (1 + 0.09)^2
Present Value = $15,000 / 1.09^2
Present Value = $15,000 / 1.1881
Present Value = $12,625.20

Option 3:
Present Value = $15,000

Option 4:
Cash Inflow in Year 1 = $5,000
Cash Inflow in Year 2 = $5,000
Rate (r ) = 7% or 3.50% semi-annually

Present Value = Future Value / (1 + r)^ n
Present Value = $5,000 / (1 + 0.035)^ 2 + $5,000 / (1 + 0.035)^ 4
Present Value = $5,000 / 1.035^ 2 + $5,000 / 1.035^ 4
Present Value = $5,000 / 1.0712 + $5,000 / 1.1475
Present Value = $4,667.66 + $4,357.30
Present Value = $9,024.96

Option 3 is best as it has highest present value of cash inflows.