You are trying to choose between two investments Everything

You are trying to choose between two investments. Everything about them is the same except that Investment A has payments that begin today and Investment B has payments that begin in 1 year. Which of the following is true? a. Choose investment A because it is worth more. b. Choose investment B because it is worth more. c. You are indifferent between the two investments.

Solution

The correct option is A.

This is because future value of annuity due/present value of annuity due is higher than the future value of annuity/present value of annuity.

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

while

Present value of annuity due=(1+interest rate)*Annuity[1-(1+interest rate)^-time period]/rate

Also:

Future value of annuity=Annuity[(1+rate)^time period-1]/rate

while

Future value of annuity due=(1+interest rate)*Annuity[(1+rate)^time period-1]/rate

Hence interest factor adds up to give higher value to A as compared to B.