Question

Over the weekend, you discovered one of your old toys is selling for $1,000 on eBay and that you could sell the toy today for that much. A collector says that instead, he can pay you $125 today and $225.41 each year for the next 5 years starting a year from today. If the bank is offering 8% annual interest per year, what do you do?

Answer 1

We can currently sell the toy for 1,000 or sell it on installations, in order to find out which one is better, we need to find the present value of the future cash flows, and we can do this by discounting the future cash flows to the present by using the annual interest rate of 8% per year

125 +

225.41/1.08= 208.713 +

224.41/1.08^2= 193.2527 +

224.41/1.08^3 178.9377 +

224.41/1.08^4= 165.6831 +

224.41/1.08^5 153.6831

=1024.997

The present value of all cash flows when discounted by 8% is 1024.997 which is more than 1,000 suggests that we should sell the toys to the collector on installments.

Step-by-step explanation: