Question

Question Three: You are offered an investment today by your broker. This investment offers the following stream of cash flows: (KN1:3.5 marks) Year 2 3 4 Cash Flows 20,000 30,000 5,000 30,000 35,000

Answer 1

The amount to be invested today is the present value of all future cash flows receivable discounted at required rate of return. This is the maximum amount that should be paid in order to get the required rate of return

Present Value factor

= 1 / ( 1 + Rate of interest ) ^ Number of years

Where,

Rate of interest = 10% or 0.10

Number of years = 0 to 5

So, PV Factor for year 2 will be

= 1 / ( 1.10 ^ 2 )

= 1 / 1.21

= 0.826446

The following table shows the calculations

Calculations	Years	0	1	2	3	4	5
A	Cash Flows	-	20,000	30,000	5,000	30,000	35,000
B	PV Factor	1.000000	0.909091	0.826446	0.751315	0.683013	0.620921
C = A x B	Present Values	-	18,182	24,793	3,757	20,490	21,732
D = Sum C	Net Present Value	88,954

So, the maximum amount that should be paid today for the investment is $ 88,954