A financial advisor offers you two investment opportunities. Both offer a rate of return of 11%. Investment A promises to pay you $450 in 1 year, $650 in 2 years, and $850 in 3 years. Investment B promises to pay you $850 in 1 year, $x in 2 years, and $450 in 3 years. What must x be to make you indifferent between Investing A and B

The value of x is 566.36

Explanation:

The value of x should be such that the present value of both Investments is the same when discounted at a rate of 11%. To calculate the present value, we use the following formula,

Present Value = CF 1 / (1+r) + CF 2 / (1+r) ^2 + ... + CFn / (1+r) ^n

Where,

CF represents Cash flow r represents the discount rate

So, we equate both the present value of Investment A and B to calculate the value of x.

Present Value of A = Present Value of B

450 / (1.11) + 650 / (1.11) ^2 + 850 / (1.11) ^3 = 850 / (1.11) + x / (1.11) ^2 + 450 / (1.11) ^3

1554.472661 = 765.7657658 + x / (1.11) ^2 + 329.0361216

1554.472661 - 765.7657658 - 329.0361216 = x / (1.11) ^2

459.6707736 * (1.11) ^2 = x

x = 566.3603602 rounded off to 566.36