Question

John Johnson is an avid stamp collector. He has been noting the rapid rise in prices for stamps printed in the 19th century. Some of the best stamps from that time period have been increasing in value by 12 percent per year. John has the rare opportunity to purchase several impressive stamps from a reputable dealer. The dealer has offered to sell the stamps to John for $65,000 today. As an alternative, John can put down $10,000 toward the purchase today and buy the stamps outright for an additional $89,500 in four years. Assume an annual discount rate of 12 percent. Assuming John has the cash for either deal, which should he take?

Answer 1

Solution

First deal

Present value =65000

Second deal

10000 today + 89500 in 4 years

Present value of 89500 has to be calculated first

Present value=Future cashflow/(1+r)^n

where

r-intrest rate=12%

n-number of periods-4

Present value=89500/(1+.12)^4

=56878.87

Thus total Present value of second deal=

56878.87+10000=

=66878.87

Since in second deal he has to give more money in terms of present value he should take the stamps for 65000 today

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