Question

1. An investment pays $40,000 in 3 years and a further $50,000 in 7 years. The interest rate over the period of the investment is a nominal rate of 9% p.a., compounded monthly. If your client can buy the investment today for $60,000 would you recommend that this is a good investment? Why or why not?

course：Business Finance

Answer 1

Monthly interest rate = 9%/12 = 0.75% or 0.0075

Next, we calculate the present value of the two cash flows, one happening after 36 months (3 years) and the next hapenning after 84 months (7 years)

The present value (PV) = FV/(1+r)^n where r is the interest rate and n is the time period. Since its compounded monthly, we use r and n in monthly terms

PV = 40,000/(1+0.0075)^36 + 50,000/(1+0.0075)^84

PV = 57,258.22 or $57,258 (Rounded)

The present value of the future cash flow is only $57,258 whereas your client is payning $60,000 for this. This is not a good investment becuase your client is paying about $2,742 more than what he shouldbe paying.