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You make two investments as follows:Investment of $100 that yields $130 after three years,Investment of $100 that yields $140 after four years,Which of the following statements is true?2 MarksThe investment with less number of resources is more preferableShort term investments are always preferableThe investment with higher Opportunity cost is preferableThe investment with higher NPV is more preferable

Question

You make two investments as follows:Investment of 100thatyields100 that yields 130 after three years,Investment of 100thatyields100 that yields 140 after four years,Which of the following statements is true?2 MarksThe investment with less number of resources is more preferableShort term investments are always preferableThe investment with higher Opportunity cost is preferableThe investment with higher NPV is more preferable

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Solution

The statement "The investment with higher NPV is more preferable" is true.

Here's why:

Net Present Value (NPV) is a financial metric that is widely used in capital budgeting and investment planning. NPV measures the profitability of a project or investment.

In this case, we need to calculate the NPV of both investments to determine which one is more preferable.

  1. For the first investment: The future value is 130andthepresentvalueis130 and the present value is 100. The investment is for 3 years. Using the formula for NPV = Future Value / (1 + r)^n - Initial Investment, where r is the rate of return and n is the number of years, we need to find a rate of return that makes the NPV = 0. Solving the equation 130 / (1 + r)^3 - 100 = 0, we get r = 9.14%.

  2. For the second investment: The future value is 140andthepresentvalueis140 and the present value is 100. The investment is for 4 years. Using the same formula, solving the equation 140 / (1 + r)^4 - 100 = 0, we get r = 8.8%.

The first investment has a higher rate of return and therefore a higher NPV, making it more preferable.

Please note that this calculation assumes that the rate of return is the same for all years, which might not be the case in real life. Also, other factors such as risk and liquidity are not considered in this calculation.

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