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Bill Preston has signed a contract that will pay him $55,000 at the beginning of

ID: 2548396 • Letter: B

Question

Bill Preston has signed a contract that will pay him $55,000 at the beginning of each year for the next 7 years, plus an additional $110,000 at the end of year 7. If 12% is the appropriate discount rate, what is the present value of this contract? Bill Preston has signed a contract that will pay him $55,000 at the beginning of each year for the next 7 years, plus an additional $110,000 at the end of year 7. If 12% is the appropriate discount rate, what is the present value of this contract? Bill Preston has signed a contract that will pay him $55,000 at the beginning of each year for the next 7 years, plus an additional $110,000 at the end of year 7. If 12% is the appropriate discount rate, what is the present value of this contract?

Explanation / Answer

Since the payment will be received at the beginning of each year for the next 7 years, First payment will be received at the beginning of Year 1 and second payment will be received at the beginning of Year 2, that is at the end of Year 1

So, Cash flows from Year 2 to Year 7 will be discounted as per the following table with PV Factor for year 1 being used for cash flow for year 2 and like wise all cash flows will be discounted

PV Factor

= 1 / (1 + r) ^ n

Where,

r = 12% or 0.12

n = 1 to 7

So, PV Factor for year 2

= 1 / (1.12^2)

= 1 / 1.2544

= 0.797193

Calculations A B C = A x B Year Payment time Payment PV Factor Present Value 0 Beginning of Year 1 55000 1.000000           55,000.00 1 Beginning of Year 2 55000 0.892857           49,107.14 2 Beginning of Year 3 55000 0.797194           43,845.66 3 Beginning of Year 4 55000 0.711780           39,147.91 4 Beginning of Year 5 55000 0.635518           34,953.49 5 Beginning of Year 6 55000 0.567427           31,208.48 6 Beginning of Year 7 55000 0.506631           27,864.71 7 End of Year 7 110000 0.452349           49,758.41 Present Value of contract        330,885.82