Question

Mr. Ahmet owes Mr. Mehmet a certain amount of money. It must be € 8,000 in t1, € 6,000 in t2 and in
t3 pay € 5,000 (i = 8%) His friend Mehmet wants to help Ahmet: If Ahmet is ready, at the end of the year in
t3 to pay Mehmet an amount of € 21,000, Mehmet wanted Ahmet’s debts immediately
settle.
a) Should Ahmet accept Mehmet's proposal? Explain Ahmet's decision!
b) Would Ahmet change his decision if the interest rate i 12%? Why? Justify yours
Answer.

Answer 1

A

Present Value of current Debt = Sum of (Value at t/(1+i)^t)

=8000/(1+8%)^1 + 6000/(1+8%)^2 + 5000/(1+8%)^3

=$16520.60

Present Value of Debt in lieu of these Debt = 21000/(1+8%)^3

=16670.48

Present Value of Repayment of debt is Less in case of Current Repayment schedule. So Ahmet should not Accept his offer.

B.

Interest rate (i)= 12%

Present Value of current Debt = Sum of (Value at t/(1+i)^t)

=8000/(1+12%)^1 + 6000/(1+12%)^2 + 5000/(1+12%)^3

=$15484.92

Present Value of Debt in lieu of these Debt = 21000/(1+12%)^3

=14947.3852

Present Value of Repayment of debt is more in case of Current Repayment schedule. So Ahmet should Accept his offer. Answer is yes, Accept the proposal