Question

Using only the Excel functions, please solve the following questions: 2. [Interest Rates]: Well-known financial writer Andrew Tobias argues that he can earn 200% per year buying wine by the case. Specifically, he assumes that he will consume one $10 bottle of fine Bordeaux per week for the next 12 weeks. He can either pay $10 per week or buy a case of 12 bottles today. If he buys the case, he receives a 10 percent discount and, by doing so, earns the 177 percent. Assume he buys the wine and consumes the first bottle today. Do you agree with his analysis? Do you see a problem with his numbers?

Answer 1

Cost of Case = Number of bottles * cost per bottle * (1-discount rate) = 12 * $10 * (1-0.10) = $108

Now lets calculate interest rate with the help of PVA formula , when cash flows are given on annuity due basis:

PVA due = PMT * ((1/i)-(1/i(1+i)ⁿ)) * (1+i)

Hence, $108 = $10 ((1/i)-(1/i(1+i)¹²)) * (1+i)

On solving for i in the above equation, we get i = 1.98%

Now APR on the investment = APR = 0.0198 * 52 = 102.77%

EAR = (1+(APR/m)^m-1 = (1+(1.0277/52)⁵² – 1 = 176.68%

From the above analysis it is clear that he would be making approximately 177% if he buys per case and if he receives a 10% discount.