Question

Read the following prompt. Choose an answer from the list of three offers. You must show your work to receive credit for your answer.

Prompt

Your friend asks you for your advice. He is selling his car. He has three offers and asks you which one he should accept? He can invest his money at a rate of 5% (that is the I). Here are the offers:

1. Selling Price: $6,000, PMT: $6,000 cash today
2. Selling Price: $6,000, PMT: $3,000 cash today and $3,000 cash 3 years from now.
3. Selling Price: $6,500, PMT: $2,500 cash today and $4,000 cash 3 years from now

Answer 1

Ans:- we will find the Present Value (PV) in each option and will choose the one which has the highest PV value

PV is calculated by CF1/(1+r)^1+CF2/(1+r)^2...................CFn/(1+r)^n, wherecF1 to CFn is the cash flow from year 1 to year n, r is the rate of return, and n is the number of years.

Option a PV= $6000/(1+5%)^0=$6,000.

Option b PV= $3000/(1+5%)^0+$3000/(1+5%)^3= $5,591.51.

Option c PV= $2,500/(1+5%)^0+$4,000/(1+5%)^3 = $5,955.35.

From the above analysis, option a has the highest Present Value, therefore it should be accepted.

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