Question

You are considering investing in two different instruments. The first instrument will pay nothing for the...

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?

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Answer #1

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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