Suppose you can invest 20,000 in an investment fund that guar- antees a 10,000 cash flow after 2 years, another one for 8,000 after 3 years and final one of 6,000 after 5 years. Would you invest knowing that the annual interest rate is 7%? What if the interest rate were 5%?

To gauge whether we will invest in the fund will be based upon the NPV calculation for the investment fund.

NPV = CF2/(1+r)^2 + CF3/(1+r)^3 + CF5/(1+r)^5 - Initial investment

Where CF is the cash flow in a particular year and r is the rate of interest.

NPV techniques discount the future cash flow to obtain the present value and compare it with the initial outflow to determine if it adds value to us or not.

1) If the interest rate is 7%

NPV = 10,000/(1+7%)^2 + 8000/(1+7%)^3 + 6000/(1+7%)^5 - 20,000

= 10,000/1.1449 + 8000/1.225043 + 6000/1.4025517 - 20,000

= 8734.39 + 6530.38 + 4277.91 - 20,000

= 19,542.68 - 20,000

= - $457.32

Since the NPV is less than 0, we will not invest in the fund if the interest rate is 7%

2) If the interest rate is 5%

NPV = 10,000/(1+5%)^2 + 8000/(1+5%)^3 + 6000/(1+5%)^5 - 20,000

= 10,000/1.1025 + 8000/1.157625 + 6000/1.27628 - 20,000

= 9070.29 + 6910.70 + 4701.16 - 20,000

= 20,682.15 - 20,000

= $682.15

Since the NPV is greater than 0, we will invest in the fund if the interest rate is 5% since it adds value to us.