Question

11. A corporation promises to pay you $8 a year for 20 years and $200 after 20 years. What is the maximum amount you would pay for the security if you wanted to earn 8 percent? (5 points)

Answer 1

We have to calculate the present value of all future cash flows promised by corporation in following manner –

Year (n)	Cash flow (CF)	PV of cash flow at 8%	Formula used
1	$8	$7.41	CF/(1+8%)^1
2	$8	$6.86	CF/(1+8%)^2
3	$8	$6.35	CF/(1+8%)^3
4	$8	$5.88	CF/(1+8%)^4
5	$8	$5.44	CF/(1+8%)^5
6	$8	$5.04	CF/(1+8%)^6
7	$8	$4.67	CF/(1+8%)^7
8	$8	$4.32	CF/(1+8%)^8
9	$8	$4.00	CF/(1+8%)^9
10	$8	$3.71	CF/(1+8%)^10
11	$8	$3.43	CF/(1+8%)^11
12	$8	$3.18	CF/(1+8%)^12
13	$8	$2.94	CF/(1+8%)^13
14	$8	$2.72	CF/(1+8%)^14
15	$8	$2.52	CF/(1+8%)^15
16	$8	$2.34	CF/(1+8%)^16
17	$8	$2.16	CF/(1+8%)^17
18	$8	$2.00	CF/(1+8%)^18
19	$8	$1.85	CF/(1+8%)^19
20	$208	$44.63	CF/(1+8%)^20
Total ( Sum of PVs)		$121.45

Therefore the maximum amount you would pay is $121.45 for the security if you wanted to earn 8 percent.

Formulas used in excel calculation: