Chapter 4, Problem 4QP

Summary Introduction

To calculate: The rate of return.

Introduction:

Rate of return refers to the gain or loss on the investment. It also refers to the increase or decrease in the capital value of an investment.

Answer to Problem 4QP

The rate of return is as follows:

Particulars	Present value	Years	Interest Rate	Future value
Investment A	$715	11	6.17%	$1,381
Investment B	$905	8	8.34%	$1,718
Investment C	$15,000	23	10.26%	$141,832
Investment D	$70,300	16	9.78%	$312,815

Explanation of Solution

Given information:

Investment A has a present value of $715, future value of $1,381, and an 11-year investment period. Investment B has a present value of $905, future value of $1,718, and an 8-year investment period.

Investment C has a present value of $15,000, future value of $141,832, and a 23-year investment period. Investment D has a present value of $70,300, future value of $312,815, and a 16-year investment period.

The formula to calculate the rate of return:

$\text{P}\times {\left(1+r\right)}^t=\text{FV}$

Where,

“P” refers to the principal amount invested

“r” refers to the rate of interest or return

“t” refers to the number of years or periods of investment

“FV” refers to the future value or the current market value

Compute the rate of return of Investment A:

$\begin{array}{c}\text{P}\times {\left(1+r\right)}^t=\text{FV}\\ \$715\times {\left(1+r\right)}^{11}=\$1,381\\ {\left(1+r\right)}^{11}=\frac{\$1,381}{\$715}\\ {\left(1+r\right)}^{11}=1.9315\end{array}$

$\begin{array}{c}1+r={1.9315}^{\frac{1}{11}}\\ r=1.0617-1\\ r=0.0617\text{ or }6.17\%\end{array}$

Hence, the rate of return of Investment A is 6.17%.

Compute the rate of return of Investment B:

$\begin{array}{c}\text{P}\times {\left(1+r\right)}^t=\text{FV}\\ \$905\times {\left(1+r\right)}^8=\$1,718\\ {\left(1+r\right)}^8=\frac{\$1,718}{\$905}\\ {\left(1+r\right)}^8=1.8983\end{array}$

$\begin{array}{c}1+r={1.8983}^{\frac{1}{8}}\\ r=1.0834-1\\ r=0.0834\text{ or }8.34\%\end{array}$

Hence, the rate of return Investment B is 8.34%.

Compute the rate of return of Investment C:

$\begin{array}{c}\text{P}\times {\left(1+r\right)}^t=\text{FV}\\ \$15,000\times {\left(1+r\right)}^{23}=\$141,832\\ {\left(1+r\right)}^{23}=\frac{\$141,832}{\$15,000}\\ {\left(1+r\right)}^{23}=9.4555\\ 1+r={9.4555}^{\frac{1}{23}}\\ r=1.1026-1\\ r=0.1026\text{ or }10.26\%\end{array}$

Hence, the rate of return Investment C is 10.26%.

Compute the rate of return of Investment D:

$\begin{array}{c}\text{P}\times {\left(1+r\right)}^t=\text{FV}\\ \$70,300\times {\left(1+r\right)}^{16}=\$312,815\\ {\left(1+r\right)}^{16}=\frac{\$312,815}{\$70,300}\\ {\left(1+r\right)}^{16}=4.4497\end{array}$

$\begin{array}{c}1+r={4.4497}^{\frac{1}{16}}\\ r=1.0978-1\\ r=0.0978\text{ or }9.78\%\end{array}$

Hence, the rate of return Investment D is 9.78%.