Question

Cavincare has 50 years remaining on a service contract with Martin, Inc. Today, Martin paid $120,000 for services received last year and the annual payment increases by 2.5% each year. The firm’s required rate of return is 15%. What is the value of the contract to Cavincare? (Do not round intermediate calculations. Round the final answer to the nearest whole dollar amount.)

a.) $987,131

b.) $980,879

c.) $974,634

d.) $915,000

Answer 1

The present value will be calculated as

PV = 120000 x (1 + 1.025/1.15 + (1.025/1.15)^2 +... + (1.025/1.15)^50) = 120000 x (1 - (1.025/1.15)^50)/(1 - 1.025/1.15) = 980878.65

Option B is correct.