Sam has promised to make four payments to Joe. Each paymentis in the amount of $

Question

Sam has promised to make four payments to Joe. Each paymentis in the amount of $1,000. What is the present value of these cashflows if the annual rate is 12%, and the payments begin?

a.

One year from today, and are paid annually?

b.

Six months from today, and are paid semiannually?

c.

Three months from today, and are paid quarterly?

Which method of payments do you think Sam and Joe would preferand why? (Show your work.)

a.

One year from today, and are paid annually?

b.

Six months from today, and are paid semiannually?

c.

Three months from today, and are paid quarterly?

Explanation / Answer

Calculating Present Value of the Cash flows(PV): (Using Ms-Excel "PV" Function): (a) One year from today, and are paidannually: Interest Rate (Rate) 12% Number of Periods (Nper) 4 Annual Payment (PMT) -1,000 Present Value of Annual Cashflows (PV) $3,037.35 (b) Six months from today, and are paidsemiannually: Interest Rate (Rate) 0.12/2 Number of Periods (Nper) 4*2 Semi-annual Payment (PMT) [$1,000 / 2] -500 Present Value of Annual Cashflows (PV) $3,104.90 (c) Three months from today, and are paidquarterly: Interest Rate (Rate) 0.12/4 Number of Periods (Nper) 4*16 Semi-annual Payment (PMT) [$1,000/4] -250 Present Value of Annual Cashflows (PV) $3,140.28 Note: Sam & Joe would prefer first methodonly, becuase when comparing the present value of cashflows ofother two methods, the first method only got very less cost of cashflows. Thus, Sam & Joe would prefer only first methodthat is payments are paid annually. Calculating Present Value of the Cash flows(PV): (Using Ms-Excel "PV" Function): (a) One year from today, and are paidannually: Interest Rate (Rate) 12% Number of Periods (Nper) 4 Annual Payment (PMT) -1,000 Present Value of Annual Cashflows (PV) $3,037.35 (b) Six months from today, and are paidsemiannually: Interest Rate (Rate) 0.12/2 Number of Periods (Nper) 4*2 Semi-annual Payment (PMT) [$1,000 / 2] -500 Present Value of Annual Cashflows (PV) $3,104.90 (c) Three months from today, and are paidquarterly: Interest Rate (Rate) 0.12/4 Number of Periods (Nper) 4*16 Semi-annual Payment (PMT) [$1,000/4] -250 Present Value of Annual Cashflows (PV) $3,140.28

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