Question

Question 4 (3 pts) 1. (1 pts) Suppose you plan to deposit $100 into an account in one year and $300 into the account in three years. How much will be in the account in five years if the interest rate is 8%? 2. (1 pts) You are considering an investment that will pay you $1000 in one year, $2000 in two years and $3000 in three years. If you want to earn 10% on your money, how much would you be willing to pay? 3. (1 pts) Suppose a mutual fund offers you an investment opportunity. For each $100 investment today, it will pay you $5 per year forever. The interest rate in the loanable funds market is 10%. You can inherit your investment or sell anytime. Would you invest? Why or why not? Show your work!

Answer 1

1. The future value of the investment can be determined as

F = 100(F/P,8%, 4) + 300(F/P,8%, 2)

F = 100 x 1.084 +300 x 1.082

F = 485.9688

Future value = $ 486 (Approximately)

2. Let us assume you are required to deposit an amount P(today)

1.000 2.000 3.000 P=; (1+0.1)1 + (1+0.1)2 + (1 + 0.1)3

P= 1,000(P/A, 10%, 3) +1,000(P/G, 10%,3)

1-1.1-3 P=1,000 x = —+1,000 X- 1.13 – 0.1 x 3-1 0.12 x 1.13 0.1

S P = 4,815.9278

The present value of investment = $ 4,816 (Approximately).

3. The value of the investment can be written as

P= 5(P/A, 10%,0)

P = = $50

This investment has a present value of $ 50 but we are required to invest $ 100.  

I won't invest in the mutual fund because the market price of investment is greater than the intrinsic value of investment. Thus, the investment is overvalued or overpriced. One must not invest in overpriced instrument.

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