Question

Chapter 4 MindTap To find the present value of a cash flow expected to be paid or received in the future, you will the future value cash flow by (1 + r)". What is the value today of a $12,000 cash flow expected to be received eight years from now based on an annual interest rate of 6%? $6,023 O $7,529 O $19,126 O $11,670 Your broker called earlier today and offered you the opportunity to invest in a security. As a friend, she suggested that you compare the current, or present value, cost of the security and the discounted value of its expected future cash flows before deciding whether or not to invest. The decision rule that should be used to decide whether or not to invest should be: Everything else being equal, you should invest if the discounted value of the security's expected future cash flows is greater than or equal to the current cost of the security. Everything else being equal, you should invest if the current cost of the security is greater than the present value of the security's expected future cash flows. Everything else being equal, you should invest if the present value of the security's expected future cash flows is less than the current cost of the security Now that you've thought about the decision rule that should be applied to your decision, apply it to the following security offered by your broker: Jing Associates, LLC, a large law firm in Denver, is building a new office complex. To pay for the construction, Iing Associates is selling a security that will pay the investor the lump sum of $6,750 in five years. The current market price of the security is $5,896. Assuming that you can earn an annual return of 3.75% on your next most attractive investment, how much is the security worth to you today?

Answer 1

1. To find the present value of a cash flow expected to be paid or received in the future, you will divide the future value cash flow by (1+r)^N.

Using the above formula, Future Value = 12000, r = 6%, N = 8,

PV = FV/(1+r)^N = 12000 / ((1+0.06)^8) = $7,528.94. Hence option is $7,529

2. The decision rule that should be used to decide whether or not to invest should be : Everything else being equal, you should invest if the discounted value of security's expected future cash flows is greater than or equal to the current cost of the security.

3. Security's today's worth = Future value / (1+r)^N

=$ 6,750 / (1+ 0.0375) ^ 5

=$ 5,615.17