You are negotiating to make a 4-year loan of $25,000 to Bala Inc. To repay you,

Question

You are negotiating to make a 4-year loan of $25,000 to Bala Inc. To repay you, Bala will pay $5,000 at the end of Year 1, $6,000 at the end of Year 2, plus a fixed but currently unspecified cash flow, X, at the end of each year from Year 3 to Year 4. Bala is essentially riskless, so you are confident the payments will be made. You regard 8% as an appropriate rate of return on a low risk but illiquid 4-year loan. What cash flow must the investment provide at the end of each of the final 2 years, that is, what is X? (Note: 1.5X credit) $9,959.26 $8.126.88 $9.679.25 $8 486.94

Explanation / Answer

Select - Option - A ......... 9959.26

At 8% required rate, which we use it as discount rate, the present value of all payments from Bala Inc must be equal to 25000 loan advanced to it.

Let the payments made during last 2 years = X per Year. ( Note it was given that last 2 installments are fixed, which means they are equal)

Present value = 5000 / (1.08) + 6000 / (1.08)2 + X / (1.08)3 + X/(1.08)4 = 25000

9773.66 + X * 1.52886 = 25000

X * 1.52886 = 25000 - 9773.66 = 15226.34

X = 15226.34 / 1.52886 = 9959.26

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