Emily has $100,000 that she wants to invest and is considering the following two options:
• Option A: Investment in Redbird Mutual Fund, which is expected to produce interest income of $8,000 per year.
• Option B: Investment in Cardinal Limited Partnership (buys, sells, and operates wine vineyards). Emily’s share of the partnership’s ordinary income and loss over the next three years would be as follows:
|
Year |
Income (Loss) |
|
1 |
($ 8,000) |
|
2 |
(2,000) |
|
3 |
34,000 |
Emily is interested in the after tax effects of these alternatives over a three year horizon. Assume that Emily’s investment portfolio produces ample passive income to offset any passive losses that may be generated. Her cost of capital is 8% (the present value factors are 0.92593, 0.85734, and 0.79383), and she is in the 28% tax bracket. The two investment alternatives possess equal growth potential and comparable financial risk. Based on these facts, compute the present value of these two investment alternatives and determine which option Emily should choose.