Question

Assuming you are a rational investor, the amount you should be willing to pay for a 20-year ordinary annuity that makes payments of $4,000 per year and you require a 6% rate of return per year is closest to:

Answer 1

Answer:

PV= $45,879.68

Explanation:

Giving the following information:

Cash flow= $4,000 annually

n= 20

i= 6% compunded annually

The maximum that an investor should pay is the present value (PV).

First, we need to calculate the future value using the following formula:

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

A= annual cash flow

FV= {4,000*[(1.06^20) - 1]} / 0.06

FV= $147,142.36

Now, we can calculate the present value, we need to use the following formula:

PV= FV/(1+i)^n

PV= 147,142.36/(1.06^20)

PV= $45,879.68