Question

1. You are planning to take a spring break trip to Canada during your senior year. The trip is exactly two years away, but you want to be prepared and have enough money when the time comes.

Explain how you would determine the amount of money you will have to save in order to pay for the trip.

2. Identify the steps involved in computing the present value when you have multiple cash flows.

Answer 1

If you are planning to take a trip to cannada, you need to first determine the amount of money to spend for it or how much it cost after two years. we have to use discount rate prevailing in the market. we need to determine the future value of our cashflows matching with amount we need for trip.

we can make annuity plans, means start saving with small mothly installments or in lumpsum payment.

To find how much lumpsum you need today we have to calculate present value of it *Amount*(1/(1+r)).

If save in annuity we just need to find annuity amount , per month we need to save . we will use future value and find amount needed. We can find value of equating with future value.

For example suppose it will cost you 100,000.

time 2 years (24 months)

rate = 1 % per month

Future value = Annuity amonnt * [((1+r)^t-1)/r]

100,000= Annuity amount [(1+.01)^24-1/.01]

solving it will give annity amount . other way we can use present value formula also.

Steps for calculating present values of multiple cash flows.

1. we need to find does multiple cash flows makes up annuity ( which have constant payment at fixed interval)

2. if it is annuity we can use present value of annuity formula

3. if it doesnot qualify as annuity, we need to discount back the cashflows to year 0, individually. for each payment we need to caclate present value and then add all present value because it have same year cash flow and can be added, which was earlier not possible.

so these are few steps for calculating present value of multiple cash flows