Question

You've been offered an investment opportunity that will pay you $10,000 in three years. It is somewhat risky, so you would only take on this investment if you earned a 20% annual return with annual compounding. What is the most that you would pay for this investment today?

· are you trying to find a PV or FV?

· show your calculations using the formula

· show your calculations using the keystrokes for your financial calculator (state which financial calculator you are using)

· what would your answer be if you required monthly compounding and why is there a difference?

Answer 1

- We are trying to find the Present Value of Future Cashflow.

so we can use the below formula.

FV = PV*(1+r)^t

- PV = FV / (1+r)^t

= 10,000 / (1+0.20)^3

= $5787.0370

Will pay most this amount if annual compounding.

- You can use any financial calculator for this answer

- Monthly Compounding

r will we effective monthly rate = 20/12 = 1.666

FV = PV*(1+r)^t

- PV = FV / (1+r)^t

= 10,000 / (1+0.01667)^36

= $5515.32

.The difference is coming because of Time Value of money if you compund early you will earn more and if you compound late you wil earn less compared to early componding.

Best Compounding is Continuous Componding (E^)