Question

Suppose you are planning to raise funds for a charity. Foundation A provides $10,000 per year from today for the next twenty years. Foundation B offers $10,200 per year for twenty years but it will begin 1 year from today. Which foundation will you choose?

(a). Foundation A

(b). Foundation B

(c). Uncertain, depends on the one-year interest rate.

(d). Uncertain, depends on the interest rates for maturities 1 to 21 years.

Answer 1

It depends on the interest rates:

for example lets take the first payment:

Foundation A - $10,000 today

Foundation B - $10,200 a year later

If interest rates were 5%, 1% or 2%

It would be equivalent to foundation B paying how much today:

5% - 10200/1.05 = 9714.286$

1% - 10200/1.01 = 10099.01$

2% - 10200/1.02 = 10000$

Thus, it changes with every period. The same thing applies for every period.

Thus, answer - d) Uncertain, depends on the interest rates for maturities 1 to 21 years