1. The future value, FVn, of the lump sum deposit is ______ 2. The future vlue o

Question

1. The future value, FVn, of the lump sum deposit is ______

2. The future vlue of the mixed stream of payments is ______

3. ?Which alternative will Gina choose? a. lump sum deposit b. mixed stream of payments

Value of a single amount versus a mixed stream Personal finance problem Gina Vitale has just contracted to sell a small parcel of land that she inherited a few days ago. The buyer is willing to pay S25,242 at the closing of the transaction or will pay the amounts shown in the following table, , at the begi shown in the following table, , at the beginning of each of the next five years. Because Gina doesn't really need the money today, she plans to let it accumulate in an account that earns 7% annual interest. Given her desire to buy a house at the end of five years after closing on the sale of the lot, she decides to choose the payment alternative $25,242 single amount or the mixed stream of payments in the table-that provides the higher future value at the end of 5 years. Which alternative will she choose?

Explanation / Answer

This is a simple Future Value problem

We need to compute the Future value(FV) of the cash flows (lets name this as FV2) vs the future value of

Now assuming when the question says that its closing of txns it means that its time Zero or the present moment or the beginning of year 1.

Thus Future value of lumpsum(FV1) after 5 years is=

Thus if FV2 >FV1 then she should chose to opt for the 5 installments option else she should take the lumpsome option.

1)The interest rate is given as 7% .

now FV1 = 25242*(1+7%)^5

FV1=35,403.21$

2)Now lets find the Future value (FV2) of the 5 cash flows.

=4000*(1.07)^5+7000*(1.07)^4+8000*(1.07)^3+9000*(1.07)^2+5000*(1.07)^1

FV2 =40,240.22$

3)Thus we find that FV2 >FV1

Hence she should use mixed stream of payments (i.e option b)

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