Question

David has purchased an investment that he expects to produce an annual cash flow of $3,000 for five years. He requires an 8% rate of return compounded annually. What is the maximum amount that David can pay and still earn the required rate of return?

Answer 1

Answer:

Maximum amount to be paid    = $ 11,978.13

Explanation:

This is an example of an annuity . An annuity is a series of periodic equal cash inflows or cash  outflows occurring for certain number of years.

The maximum amount to be paid would be the present value (PV) of the cash flows discounted at the required rate of return of 8%

This would be be done using the formulae below:

PV = A × 1 - (1+r )^(-n)/r

A- 3000 r - 8%, n - 5

PV = 3000× 1 -(1.08^(-5))/0.08

   = 3000 × 3.9927

   = $ 11,978.13

Maximum amount to be paid    = $ 11,978.13