Question

Jim own an asset that will pay $1,000 in year 1, $2,000 in year 2, and 3,000 in year 3. The discount rate is 6% per year. if an investor ask Jim to sell the asset to the investor, what is the minimum price Jim would be willing to accept for the asset?

Answer 1

Now to find the present value of an amount received after nth year is given by:

CF/(1+r)^n

Here CF = Cash Flow = 1000 for year 1, 2000 for year 2, 3000 for year 3

r = 6%

n = 1,2,3 for years 1,2,3 respectively

Here the amount $1000 will be received at the end of year 1 thus it will be discounted at 6% for 1 year, the $2000 received at the end of year 2 will be discounted at 6% for 2 years and $3000 received at the end of year 3 will be discounted at 6% for 3 years.

Now putting in the values

PV = CF1/(1+r)^1 + CF2/(1+r)^2 + CF3/(1+r)^3

= 1000/(1.06) + 2000/(1.06)^2 + 3000/(1.06)^3

= 943.3962+1779.9928 + 2518.8578

= 5242.2468

= 5242.25