Your client is considering the purchase of $100,000 in common stock, which pays no dividends and will appreciate in market value by 10 percent per year. At the same time, the client is considering an opportunity to invest $100,000 in a lease obligation that will provide the annual year-end cash flows listed in Exhibit 14.23 below. Assume that each investment will be sold at the end of three years and that you are given no additional information.
Calculate the present value of each of the two investments assuming a 10 percent discount rate, and state which one will provide the higher return over the three-year period.
Exhibit 14.23 Annual Cash Flow from Lease
End of Year
1 $ 0
2 Lease receipts 15,000
3 Lease receipts 25,000
4 Sale proceeds $100,000
Present Value of $1
Period 6% 8% 10% 12%
1 0.943 0.926 0.909 0.893
2 0.890 0.857 0.826 0.797
3 0.840 0.794 0.751 0.712
4 0.792 0.735 0.683 0.636
5 0.747 0.681 0.621 0.567