Question

eBook

Problem 7-07

An investment will generate $10,000 a year for 20 years. If you can earn 9 percent on your funds and the investment costs $120,000, calculate the present value of investment. Use Appendix D to answer the question. Round your answer to the nearest dollar.
$  

Should you buy it?
-Select-Yes or no

Calculate the present value of investment, if you could earn only 5 percent. Use Appendix D to answer the question. Round your answer to the nearest dollar.
$  

Should you buy it in this case?
-Select-Yes or no

Answer 1

Q1:

PV of investment=PV of annuity payment= A*[1-(1+r)^-n]/r

where A=annuity payment =10000 ; r=interest rate=9%; n=no of years=20

PV of investment=10000*[1-(1+9%)^-20]/.09 =91285.45

The PV of investment is less than the cost for purchasing it (120000 $) . Hence we should not purchase the investment;

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Q2: 5% interest rate

PV of investment =10000*[1-(1+5%)^-20]/.05 =124622.103 $

The PV of investment is greater than the cost; Hence at 5% interest rate, we can purchase the investment option.