Question

PART 1:

The present value of an ordinary annuity is $13,000. What would be the present value of this annuity if the payments were to be received at the beginning of each period? Assume the interest rate is 18%.

A. $16,500
B. $13,636
C. $15,340
D. Insufficient information to determine – we need to know the specific cash flows and the timing

PART 2:

If you were offered a stream of cash flows of $1500 per year forever and the appropriate interest rate for an investment of this risk level was 6.8%, what is the most that you should be willing to pay for this deal?

A. Approx. $22,059
B. Approx. $18, 667
C. Approx. $8,333
D. It has infinite value because it is an infinite stream of cash flows

Answer 1

PART 1
Present value of an annuity due = Present value of an ordinary annuity*(1+r)
r is the interest rate
Present value of the annuity due = 13000*(1+.18)
Present value of the annuity due = 15340
The present value of the annuity if the payments were to be received at the beginning
of each period is
C) $15340.
PART 2
Present value of a perpetuity = C/r
where C is the payment per year that is 1500.
r is the interest rate that is .068.
Present value of the perpetuity = 1500/.068
Present value of the perpetuity = 22058.82.
A) Approx $22059.