Question

You are selling an asset. you can earn an interest rate of 7% per yer on your savings. You receive the following two (risk less) offers:

Offer 1: receive $400,000 today
Offer 2: Receive $500,000 in 4 years

a. Which offer should you choose?
b. At what interest rate would you be indifferent between the two offers?

Answer 1

Option 1

5.737126344%

Step-by-step explanation:

to determine which option i would prefer today, i would need to determine the present value of offer 2

Present value is the sum of discounted cash flows

`(500,000)/(1.07^(4) )` = $381,447.61

I would prefer the first option because its present value is greater than that of option 2

The interest rate that would make me indifferent between either options would be the interest at which the present value of $500,000 in 4 years is $400,000

$400,000 =
`(500,000)/((1 + x)^(4) )`

$400,000
`(1 + x)^(4)` = $500,000

500,000 / 400,000= (1 + x)^{4}

1.25 = (1 + x)^{4}

`1.25^(0.25)` = 1 + x

x = 5.737126344%