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Jim Nance has been offered an investment that will pay him $500 three years from today. If his...

Question:

Jim Nance has been offered an investment that will pay him $500 three years from today.

If his opportunity cost is 7% compounded annually, what value should he place on this opportunity today?

Present Value:

Present value is a concept that allows investors to compare cash flows received at different points in time. The present value calculation indicates the equivalent value of a future cash flow measured in today's dollars.

Answer and Explanation:

The value today is the present value of the payment received in three years. We can use the following formula to compute the present value of a payment {eq}F {/eq} received in {eq}T{/eq} periods from today, given periodic discount rate {eq}r{/eq}:

  • {eq}\displaystyle \frac{F}{(1 + r)^T} {/eq}

Applying the formula, the present value is:

  • {eq}\displaystyle \frac{500}{(1 + 7\%)^3} = 408.15 {/eq}

That is, he should pay no more than $408.15 for the opportunity today.


Learn more about this topic:

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How to Calculate Present Value of an Investment: Formula & Examples

from Introduction to Business: Homework Help Resource

Chapter 24 / Lesson 15
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