Question

A company is considering an investment that will return $30,000 semiannually at the end of each semiannual period for 4 years. If the company requires an annual return of 10%, what is the maximum amount it is willing to pay for this investment

Answer 1

Answer: $193,896.38

Step-by-step explanation:

The maximum value that the company will pay is one that equals the present value of the cashflows of this project because anything higher will lead to losses.

The maximum value is therefore the present value of the cashflow here.

Annual rate to periodic rate = 10%/2 = 5%

No. of periods = 4 * 2 = 8 semi annual periods

Payment is fixed so is an annuity.

Present value of annuity = Annuity * ( 1 - (1 + rate) ^ -n) / rate

= 30,000 * (1 - ( 1 + 5%)⁸) / 5%

= $193,896.38

The company should not pay anything more than this amount because that would lead to a loss.