Answer to Question #195099 in Economics of Enterprise for Joyce

Question

At EOY zero (now), a geometric gradient has a positive cash flow of $1,000 and for the following 5 years, it rises by 5 percent each year. At EOY 1, another geometric gradient has a positive value of $2,000, and for years two through five, it decreases 6 percent every year. What geometric gradient would you prefer, if the annual interest rate is 10 percent?

Answer 1

Present Value (PV) is current value of amount to be transacted in future. It is computed by discounting that future amount.

WORKINGS

It is evident from the above calculation that the present value of cash flows of the second option is more than the first one, therefore, option 2 would be preferred.