Question

On Joe Martin’s graduation from college, Joe’s uncle promised him a gift of $12,000 in cash or $900 every quarter for the next 4 years after graduation. Assume money could be invested at 8% compounded quarterly. a. Calculate the present value of options. (Do not round intermediate calculations. Round your answer to the nearest cent.) b. Which offer is better for Joe? Option 1 Option 2

Answer 1

Answer:

Instructions are below.

Explanation:

Giving the following information:

Option 1:

$12,000 cash now

Option 2:

$900 every quarter for 4 years.

Interest rate= 8% compounded quarterly

We need to determine the present value of option 2.

First, we need to calculate the future value of the investment. We will use the following formula:

FV= {A*[(1+i)^n-1]}/i

A= cash flow= 900

n= 4*4= 16

i= 0.08/4= 0.02

FV= {900*[(1.02^16)-1]} / 0.02

FV= $16,775.36

Now, we determine the present value:

PV= FV/(1+i)^n

PV= 16,775.36/(1.02^16)

PV= $12,219.94

It is more profitable to accept option 2. It provides the highest present value.