Question

BUSI 320 Problem#3 (Decision #1)

Use what you have learned about the time value of money to analyze each of the following decisions:

Decision #1:   Which set of Cash Flows is worth more now?

Assume that your grandmother wants to give you generous gift. She wants you to choose which one of the following sets of cash flows you would like to receive:

     Option A: Receive a one-time gift of $10,000 today.   

Option B: Receive a $1600 gift each year for the next 10 years. The first $1600 would be received 1 year from today.

Option C: Receive a one-time gift of $20,000 10 years from today.

Compute the Present Value of each of these options if you expect the interest rate to be 3% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________ today.

       Option C would be worth $__________ today.

       Financial theory supports choosing Option _______

       

Compute the Present Value of each of these options if you expect the interest rate to be 6% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

     Option A would be worth $__________ today.

    Option B would be worth $__________ today.

    Option C would be worth $__________ today.

      Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect to be able to earn 10% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________ today.

       Option C would be worth $__________ today.

       Financial theory supports choosing Option _______

Answer 1

Decison # 1

Option A; PV = $10,000

Option B; PV =

using above formula, PV = 1600 x (( 1 - 1/(1+.03)^10)) / (.03) = 13,648

Option C; PV = FV / (1+r)^n = 20000 / (1+0.03)^10 = 14,882

Hence select Option C

Decision # 2: with 6%,

Option A; PV = 10000

Option B; PV = 1600 x ((1-1/(1+0.06)^10) / (0.06) = 11776

Option C; PV = 20000 / (1+0.06)^10 = 11167

Hence, select option B

Decision # 3:

Option A; PV = 10000

Option B; PV = 1600 x (1-1/(1+.1)^10))/0.1 = 9831

Option C; PV = 20000 / (1+0.1)^10 = 7711

Hence, select option A