Suppose a State of Nevada bond will pay $1,000 eight years from now. If the going interest rate on these 8-year bonds is 5.5%, h
1 answer:
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Answer:
Option 1 Present value = $18,181,818.18
Option2 Present value = $20,916,718.64
Option 2 which is an annuity for 15 years is a better option as it has a higher present value than option 1.
Explanation:
To decide the better option, we need to calculate the present value of option 1 which is the lumpsum and the present value of option 2 which is an annuity and compare these values.
The present value of option 1 can be calculated as follows,
Option 1 Present value = Future value / (1 + r)^t
Where,
- r is the rate of return of interest or discount rate
- t is the time in years
Option 1 Present value = 20,000,000 / (1+0.1)^1
Option 1 Present value = $18,181,818.18
The present value of option 2 can be calculate using the formula of present value of annuity due as the payments will be made at the start of the period. The formula for present value of annuity due is attached.
Option2 Present value = 2,500,000 + 2,500,000 * [(1 - (1+0.1)^-14) / 0.1]
Option2 Present value = $20,916,718.64
Option 2 which is an annuity for 15 years is a better option as it has a higher present value than option 1.
