5. Present value Aa Aa To find the present value of a cash flow expected to be p

Question

5. Present value Aa Aa To find the present value of a cash flow expected to be paid or received in the future, you will future value cash flow by (1 +I)N the What is the value today of a $12,000 cash flow expected to be received nine years from now based on an annual interest rate of 9%? O $4,420 $5,525 $8,564 $6,906 Your broker called earlier today and offered you the opportunity to invest in a security. As a friend, he 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 present value of the security's expected future cash flows is less than the current cost of the security 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. 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: ing Associates, LLC, a large law firm in Denver, is building a new office complex. To pay for the construction, Jing Associates is selling a security that will pay the investor the lump sum of $17,500 in six years. The current market price of the security is $12,372 Assuming that you can earn an annual return of 6.75% on your next most attractive investment, how much is the security worth to you today? $9,461 $11,826 $15,965 From strictly a financial perspective, should you invest in the Jing security? Yes O No Why or why not? Because the discounted value of the security's future cash flows is greater than the cost of the security Because the cost of the security is greater than the discounted value of the security's future cash flows

Explanation / Answer

1). To calculate the present value, you have to divide the future value cash flow by (1+ I)^n. The formula for present value is = Future Value / (1+I)^n.
Hence the answer is divide.

2). Present value of $12000 to be received 9 years from now. Discounting rate is 9%.
P.V = $12000 / (1 + 0.09)^9
= $12000 / 2.1719
= $5525.11
Hence the answer is b). $5525

3). Answer is b). Everything else be equal, you should invest when the discounted value of the security's future cash flows is greater than or equal to the current cost of the security.
Here you should compare what you are paying now and what you are going to receive in future. For comparing the future value you have to calculate it's present value/ discounting value and then compare it with the present cost of security. If your present value is less then you will get loss and if your present value is high than the cost then you are in profit.

4). Security will give you lumpsum $17500 in 6 years. To calculate it's worth now you have to calculate its present value.
PV = $17500 / (1 + 0.0675)^6
= $17500 / 1.4798
= $11826
Hence the answer is b).

5). As you are paying now $12372 and it's present worth is $11826. You are in loss hence you should not invest in this security. Answer is NO.

6). Answer is b). Because the cost of security is greater than the discounted value of the security's future cash flows.
$12372 > $11826.

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