Question

Tony Bowie is trying to determine the amount to set aside so that he will have enough money on hand in 4 years to overhaul the engine on his vintage used car. While there is some uncertainty about the cost of engine overhauls in 4 years, by conducting some research online, Tony has developed the following estimates.

Engine Overhaul Estimated Cash Outflow Probability Assessment
$330 10%
460 30%
750 50%
950 10%

Required:
How much should Keith Bowie deposit today in an account earning 6%, compounded annually, so that he will have enough money on hand in 6 years to pay for the overhaul?

Answer 1

$507.73

Step-by-step explanation:

first we need to calculate the expected cost of overhauling the engine in 4 years:

$330 x 10% = $33

$460 x 30% = $138

$750 x 50% = $375

$950 x 10% = $95

Expected cost = $641

now we must find the present value = $641 / (1 + 6%)⁴ = $507.73