Question

Cavincare has 50 years remaining on a service contract with Martin, Inc. Today, Martin paid $120,000 for services received last year and the annual payment increases by 2.5% each year. The firm’s required rate of return is 15%. What is the value of the contract to Cavincare? (Do not round intermediate calculations. Round the final answer to the nearest whole dollar amount.

Answer 1

Answer:

$980,879

Explanation:

Recall that

PVAn = (CF1 / (i - g)) × [1 - ((1+g)n/ (1+i))n]

Where

CFI = 120000 × 2.5%

= 123000

i = 15%

g = 2.5%

n = 50

Thus

PVAn = ($123,000 / (15% - 2.50%)) × [1 - ((1+2.5%)50 / (1+15%))50]

= 984000 × 1 - (51.25)/(57.5)

= 984000 × 0.996828

= 980,878.752

= $980, 879