Question

What is the most a rational investor should be willing to pay for the right to receive $12,000 per year (the first payment is at the end of the first year) for 20 years if her annual opportunity cost is 12%?  (Choose the closest answer)

Answer 1

This question requires application of PV of annuity formula, according to which

PV =

[1-(4+5)-) [1-(1+r)-n LT P= Periodic Payment r=rate per period n = number of periods

For this question,

$PV = 12000 * [\frac{1 - (1 + 0.12)^{-20}}{0.12}]$

PV = 20000 * 7.469444

PV = $89,633.32