Question

Decision #1:   Which set of Cash Flows is worth more now?

Assume that your grandmother wants to give you generous gift. She wants you to choose which one of the following sets of cash flows you would like to receive:

Option A: Receive a one-time gift of $ 10,000 today.   

Option B: Receive a $1400 gift each year for the next 10 years. The first $1400 would be

     received 1 year from today.                 

Option C: Receive a one-time gift of $17,000 10 years from today.

Compute the Present Value of each of these options if you expect the interest rate to be 3% annually for the next 10 years.    Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________ today.

       Option C would be worth $__________ today.

       Financial theory supports choosing Option _______

       

Compute the Present Value of each of these options if you expect the interest rate to be 6% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________ today.

       Option C would be worth $__________ today.

      Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect to be able to earn 9% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________ today.

       Option C would be worth $__________ today.

       Financial theory supports choosing Option _______

Answer 1

	Option A	Option B	Option C
Payment term	10,000	1,400	17,000
No of payments	1	10	1
Payment time	Today	for 10 years	At 10th year
PV of annuity for making pthly payment
P = PMT x (((1-(1 + r) ^- n)) / i)
Where:
P = the present value of an annuity stream
PMT = the dollar amount of each annuity payment
r = the effective interest rate (also known as the discount rate)
i=nominal Interest rate
n = the number of periods in which payments will be made
Present Value @ 3%=	10,000	= 1400* (((1-(1 + 3%) ^- 10)) / 3%)	17000/(1+3%)^10
Present Value @ 3%=	10,000.00	11,942.28	12,649.60
So option C is preferable
Present Value @ 6%=	10,000	= 1400* (((1-(1 + 6%) ^- 10)) / 6%)	17000/(1+6%)^10
Present Value @ 6%=	10,000.00	10,304.12	9,493
So option B is preferable
Present Value @ 9%=	10,000	= 1400* (((1-(1 + 9%) ^- 10)) / 9%)	17000/(1+9%)^10
Present Value @ 9%=	10,000.00	8,984.72	7,181
So option A is preferable