Nancy is considering forming a 5 year business partnership with Claudi

Nancy is considering forming a 5 year business partnership with Claudia. Nancy believes her portion of the partnership will generate the following profits:

Year Profits Present Value
1 $2,000
2 $4,000
3 $12,000
4 $15,000
5 $18,000

Nancy’s appropriate discount rate is 6%. To join the partnership, Nancy needs to invest $30,000. Does the partnership offer a rate of return in excess of 6%?

ANSWER

As the table below indicates, the present value of the partnership is in excess of the $30,000 investment. This implies the partnership offers a rate of return greater than 6%. In this case, Nancy should join the partnership.

Year Profits Present Value
1 $2,000 1,886.79
2 $4,000 3,559.99
3 $12,000 10,075.43
4 $15,000 11,881.41
5 $18,000 13,450.65
TOTAL $40,854.27