You are considering investing in two different instruments. The first instrument will pay nothing for the first three years, but then it will pay $40,000 per year for five years after that. The second instrument will pay $25,000 for seven years and $40,000 in the eighth year. All payments are made at year-end. If your rate of return on these investments is 6 percent annually, what should you be willing to pay for each instrument today?
Instrument 1:
Year | Cash inflows | PVF @ 6% | PV of cash flows |
1 | 0 | 0.943396226 | 0 |
2 | 0 | 0.88999644 | 0 |
3 | 0 | 0.839619283 | 0 |
4 | 40000 | 0.792093663 | 31683.74653 |
5 | 40000 | 0.747258173 | 29890.32691 |
6 | 40000 | 0.70496054 | 28198.42162 |
7 | 40000 | 0.665057114 | 26602.28454 |
8 | 40000 | 0.627412371 | 25096.49485 |
Total | 141471.2745 |
You should be willing to pay $ 141471.2745
Instrument 2:
Year | Cash inflows | PVF @ 6% | PV of cash flows |
1 | 25000 | 0.943396226 | 23584.90566 |
2 | 25000 | 0.88999644 | 22249.911 |
3 | 25000 | 0.839619283 | 20990.48208 |
4 | 25000 | 0.792093663 | 19802.34158 |
5 | 25000 | 0.747258173 | 18681.45432 |
6 | 25000 | 0.70496054 | 17624.01351 |
7 | 25000 | 0.665057114 | 16626.42784 |
8 | 40000 | 0.627412371 | 25096.49485 |
Total | 164656.0308 |
You should be willing to pay $ 164656.0308.
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