Question
In: Finance
Your mother and father are retired and need income to live on. The local financial advisor...
- Your mother and father are retired and need income to live on.
The local financial advisor offers to sell them a product that will
provide them $75,000 a year for 15 years. Prevailing interest rates
are 8%. The cost to purchase the product is $750,000.
- They asked you to evaluate the offer. Do you recommend they purchase the product? Why?
- If prevailing interest rates were 5%, would it change your recommendation? Why?
Solutions
Expert Solution
In order to evaluate this investment proposal, we need to evaluate the npv of the total investment of $750,000 made in year 0 and the future cash flows. Npv is the sum of present values of each cash flows. If the NPV is negative, this means that the investment is not to be recommended while a positive npv may mean that the investment can be made as the money earned on the investment is worth more today than the costs., therefore, it is a good investment.
Present value of a cash flow = Cash flow / ((1+rate of interest)^no. of years)
Please refer to the below tables in excel. I have shown each calculations for the present value and have summed each of the present values of the individual cash flows to obtain the npv
Scenario 1 , when the rate of interest is 8%
As shown in the calculation, the sum of present values for each cash flow comes out to be -$108,039.10. Since the NPV is negative, I would not recommend them to purchase the product.
Scenario 2 , when the rate of interest is 5%
As shown in the calculation, the sum of present values for each cash flow comes out to be $28,474.35. Since the NPV is positive, I would recommend them to purchase the product, based on the available information.
Hope this answers your question.
jeff jeffy answered 1 year agoRelated Solutions
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