Question

3)You have won a contest and are allowed to choose between two prizes. One option is to receive$200 today and another $200 one year from now. The second option is $100 today and anadditional $325 one year from now. At what interest rate (if any) is the present value of the twoprizes identical?3)A)0 percentB)5 percentC)25 percentD)10 percentE)none of the above

Answer 1

Answer:

C)25 percent

Explanation:

Present value is the sum of discounted cash flows.

The interest rate where the present value of the two two prizes would be identical can be found using a financial calculator and trial and error method.

Option A :

Cash flow for year zero = $200

Cash flow for year one = $200

Present value when I is 0 = $400

Present value when I is 5 = $390.48

Present value when I is 10 = $381.82

Present value when I is 25 = $360

Option B

Cash flow in year 0 =$100

Cash flow in year 1 = $325

Present value when I is 0 = $425

Present value when I is 5 = $409.52

Present value when I is 25 = $360

Present value when I is 10 = $395.45

It can be seen that it's at 25% that both cash flows would be equal.

To find the PV using a financial calacutor:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute

I hope my answer helps you