Question

You are considering an investment that promises to pay $1,000 per year for the next 10 years. The interest rate associated with investments having similar risk is 6.0%.

How much would you be willing to pay for this investment? Hint: students may wish to use Excel to facilitate the calculations

Answer 1

The amount that should be paid for the Investment is equal to the present value of the promised income from the investment discounted at the appropriate discount rate reflecting the riskiness of the investment

So,

Amount that I am willing to pay = 1000/1.06+1000/1.06^2+...+1000/1.06^10

(assuming that the amounts are paid at the end of the year

= 1000/0.06*(1-1/1.06^10)

=$7360.09

So, the amount that I am willing to pay for the investment is $7360.09

Please note that if the amount of $1000 is paid at the beginning of each year, the amount that I would be willing to pay will increase and will now be = 7360.09*1.06 =$7801.69