Question

You require an 8% annual return on all investments. You will receive $1,000, $2,000, and $3,000 respectively for the next three years (end of year) on a particular investment. What is the most you would be willing to pay for this investment

Answer 1

I will pay $5,022 for this Investment.

Step-by-step explanation:

The value of the investment can be determined by calculating the present value of all the relevant cash flows of the investment.

use Following formula:

Pv = Fv / (1+r)^n

PV of year 1 Cash flow = $1,000 x ( 1 + 0.08 )^1 = $926

PV of year 2 Cash flow = $2,000 x ( 1 + 0.08 )^2 = $1,715

PV of year 3 Cash flow = $3,000 x ( 1 + 0.08 )^3 = $2,381

Total Value of Investment = $926 + $1,715 + $2,381 = $5,022

I will pay $5,022 for this Investment.

Answer 2

$5,026

Step-by-step explanation:

Year 1 Year 2 Year 3

Cash flows 1,000 2,000 3,000

Discount factor 1/1.08 1/(1.08)^2 1/(1.08)^3

Discount Factor= .93 .86 .79

Cash flows*discount factor

1000*.93 2000*.86 3000*.79

Net present value of cash flows

930 1,715 2,381

930+1715+2381=5,026 is the maximum amount one can pay for this investment