Question

An obligation can be settled by making a payment of $6,000 now and a final payment of $2,500 in five years (Alternative 1). Alternatively, the obligation can be settled by payments of $700 at the end of

every six months for seven years. Interest is 12% compounded semi-annually. Compute the present value of each alternative and determine the preferred alternative according to the
discounted cash flow criterion

Answer 1

The present value of two payment alternatives to settle an obligation must be calculated, accounting for a 12% interest rate compounded semi-annually, using present value formulas for lump sums and annuities.

Step-by-step explanation:

The question asks to calculate the present value of two different payment alternatives for settling an obligation, taking into account the interest rate of 12% compounded semi-annually. To find the present value, we compare the discounted cash flow of both alternatives. Alternative 1 involves a payment of $6,000 now and a final payment of $2,500 after five years. Alternative 2 is a series of $700 payments every six months for seven years.

To determine the present value, we use the formula for the present value of a lump sum for the payments in Alternative 1, and for Alternative 2, we utilize the formula for the present value of an annuity. The alternative with the lower present value will be the preferred choice according to discounted cash flow criterion.