You are given two choices of investments, Investment A and Investment B. Both investments have the same future cash flows. Investment A has a discount rate of 4%, and Investment B has a discount rate of 5%. Which of the following is true?

A. The present value of cash flows in Investment A is lower than the present value of cash flows in Investment B.

B. The present value of cash flows in Investment A is higher than the present value of cash flows in Investment B.

C. The present value of cash flows in Investment A is equal to the present value of cash flows in Investment B.

D. No comparison can be madelong dash-we need to know the cash flows to calculate the present value.

The answer is: B) The present value of cash flows in Investment A is higher than the present value of cash flows in Investment B.

Explanation:

The present value of a cash flow is the current value of a future amount of money discounted by an specific rate of return.

Both investments will have the same cash flows, but investment B has a higher discount rate than investment A. The cash flows of investment A will have a higher present value than the cash flows of investment B.

For example, both investments A and B have a future cash flow of $100, but investment A has a discount rate of 4% while investment B has a discount rate of 5%.

The present value of the cash flow for investment A is $96.15 ( = $100 / 1.04)

The present value of the cash flow for investment B is $95.24 ( = $100 / 1.05)