You may to invest in a coffee plantation in South Australia. The investment promises to pay $5,000 at the end of year 3, $5,000 at the end of year 4, $5,000 at the end of year 6 and $10,000 at the end of year 10. Similar investments return approximately 15%. How much are you be prepared to pay for this investment?
figure the present value of the four payments, then add.
That is what you should pay, no more.
Is it like this: 5000/1.15^3+5000/1.15^4+5000/1.15^6+10000/1.15^10=10780?
yes
Thank you again Reiny
To calculate the present value of this investment, we need to discount each future cash flow back to its present value using the given discount rate of 15%.
Let's break it down step by step:
1. Calculate the present value of each cash flow. The formula to calculate the present value is:
Present Value = Future Value / (1 + Discount Rate)^N
N is the number of years in the future.
Using this formula, we can calculate the present value of each cash flow as follows:
- Present Value of $5,000 at the end of year 3:
PV1 = $5,000 / (1 + 0.15)^3
- Present Value of $5,000 at the end of year 4:
PV2 = $5,000 / (1 + 0.15)^4
- Present Value of $5,000 at the end of year 6:
PV3 = $5,000 / (1 + 0.15)^6
- Present Value of $10,000 at the end of year 10:
PV4 = $10,000 / (1 + 0.15)^10
2. Add up the present values to find the total present value of the investment:
Total Present Value = PV1 + PV2 + PV3 + PV4
3. Calculate the maximum amount you should be prepared to pay for this investment, which is the total present value. This represents the fair value or the maximum amount justified by the expected cash flows and the given discount rate.
Therefore, to determine the maximum amount you should be willing to pay for this investment, you need to calculate the total present value by performing the steps mentioned above.