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

1). TI BA II Plus calculator:

ON --> 2nd --> CLR TVM --> CE|C (for clearing memory and screen)

Enter "-10,000" ---> Press FV

Enter "3" --> Press N (for number of years)

Enter "20%" --> Press I/Y (for annual return)

Press CPT --> PV (for calculating PV)

PV = 5,787.04 (You should not pay more than this for the investment.)

2). PV with monthly compounding:

Steps remain the same as above, except the values become

FV = -10,000; N = 36 ( monthly compounding so 3*12 = 36); I/Y = 1.6667% (calculated as 20%/12 = 1.6667%), CPT PV.

PV = 5,515.32

3). The present values differ in both cases because the number of compoundings during the term is different for both. As a result, the present value with lower frequency of compounding is more than the present value with higher frequency of compounding.

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