Question

Your friend Smith is holding a silent auction on his three karaoke machines. He will only sell the three machines as a group. You figure that if you bought the machines, you can rent them out for annual profit of $6,000. The machines are estimated to have a life of 3 years, after which you will discard it at no cost. What is the maximum bid you can submit for each machine if your required return is 10%? Ignore taxes

Answer 1

Annual exoected rent from 3 machines: $ 6,000

Time period: 3 years

Required rate of return: 10%

Hence,

Present value of annual expected rent as on today: $ 6,000 * PVAF @10% , 3 years

Present value of annual expected rent as on today: $ 6,000 * 2.48685 = $ 14,921.10

Therefore, we can pay bid maximum $ 14.921.10 for all three machines because if we bid more than this amount, it will resulting to start loss.

Maximums bid for each machine is: $ 14,921.10 / 3 = $4973.70