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

QUESTION

Time value Jim Nance has been offered an investment that will pay him $500 three years from today.a. If his opportunity cost is 7% compounded annually, what value should he place on this opportunity today?b. What is the most he should pay to purchase this payment today?c. If Jim can purchase this investment for less than the amount calculated in part a, what does that imply about the rate of return that he will earn on the investment?
Solution: For Jim Nance: Future Value = $500 Time Period = 3 Years (a) Opportunity Cost = 7% Present Value = Future Value/(1+r)^n So, Present Value = $500/(1+7%)^3 = $408.15 (b) If Opportunity Cost = 0% Present Value = $500/(1+0%)^3 = $500 Maximum purchase payment should be $500. (c)

t Purchase Payment = $400 Future Value = $500 $500 = $400*(1+Interest Rate)^3 So, Required Rate of Return = 7.72% If the purchase investment is less thenrequired rate of return will increase.

ANSWER:

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