Question

Lee has made a nonrefundable deposit of the first month’s rent (equal to $900) on a

apartment lease to 6 months. The same day later Lee finds a different apartment that
he likes just as well, but its monthly rent is cheaper and negotiable. Assume a nominal
rate interest rate of 8% convertible monthly. The rent will be paid monthly and at the
beginning of each month.

(i) Write down the cash flow and compute the present value (to 2 decimal numbers)
of 6 months if Lee rents the first apartment ($900).
(ii) Find the range of the rent (to 2 decimal numbers) of the cheaper apartment such
that Lee would switch to rent the new apartment.

Answer 1

(i) To calculate the present value of 6 months of rent for the first apartment, we can use the formula PV = FV / (1 + r)^n, where PV is the present value, FV is the future value (6 months of rent, or $900 x 6 = $5400), r is the interest rate (8% converted to a monthly rate, or 0.08/12 = 0.0067), and n is the number of periods (6 months). So, PV = $5400 / (1 + 0.0067)^6 = $4911.46

(ii) To find the range of rent for the new apartment such that Lee would switch, we need to find the monthly rent that would result in a present value equal to or greater than $4911.46. Using the same formula, we can solve for the monthly rent (R) by setting PV equal to $4911.46 and n equal to 6. So, $4911.46 = R*(1+0.0067)^6. Solving for R, we get that the monthly rent must be between $732.32 and $766.58 in order to be more favorable than the first apartment.