An investment offers an expected dollar return of $800 each year for years 1 through 5. If the interest rate is 12%, what is the present value of this investment?
To calculate the present value of an investment, you need to use a financial formula called the present value formula. The formula for calculating the present value of an investment with a fixed expected dollar return per year is:
PV = C / (1 + r)^n
Where:
PV = Present Value
C = Cash flow in each year (the expected dollar return)
r = Interest rate per period (in this case, annual interest rate)
n = Number of periods (in this case, number of years)
In this case, the expected dollar return per year is $800, the interest rate is 12% (or 0.12), and the investment is for 5 years. Plugging in these values into the formula, we get:
PV = $800 / (1 + 0.12)^5
Calculating the value inside the parentheses first, we have:
PV = $800 / (1.12)^5
Next, calculate (1.12)^5, which is 1.762341683.
Finally, divide $800 by 1.762341683 to get the present value:
PV = $800 / 1.762341683 ≈ $453.42
Therefore, the present value of this investment is approximately $453.42.