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You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and 10. If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment? Select one: a. $15,819.27 b. $21,937.26 c. $32,415.85 d. $38,000.00 e. $52,815.71

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mltn1980

Answer:

b. $21,937.26

Explanation:

To calculate how much it's willing to pay for the investment it's needed to apply the concept of Net Present Value which compute the future cash flows to a present value which lets you analize if it is a profitable investment.

The criteria to accept the investment is that the present value of all the future cash flows must be zero or positive with the discount rate utilized, in this case  14%.

The formula to calculate the Cash Flow:

NPV

        Ct

∑   ======

      (1+r)^t

Where:

Ct = Cash Flow of each moment t

t = each year  = period from 1 to 10

r = discount rate = 14%

14% Discount Rate  

         $ 21,937

1 $ 5,000 $ 4,386

2 $ 5,000 $ 3,847

3 $ 5,000 $ 3,375

4 $ 5,000 $ 2,960

5 $ 5,000 $ 2,597

6 $ 3,000 $ 1,367

7 $ 3,000 $ 1,199

8 $ 3,000 $ 1,052

9 $ 2,000 $ 0,615

10 $ 2,000 $ 0,539

 

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