A train company has signed a contract to deliver a new fuel driven train 3 years from now. The price they will receive at the end of 3 years is $20 million. If the firm's cost of capital is 6%, what is the present value of this payment?
A train company has signed a contract to deliver a new fuel driven train 3 years from now. The price they will receive at the end of 3 years is $20 million. If the firm's cost of capital is 6%, what is the present value of this payment?
To calculate the present value of a future payment, we need to discount it using the firm's cost of capital. The formula for calculating present value is:
PV = FV / (1 + r)^n
Where PV is the present value, FV is the future value, r is the discount rate (cost of capital), and n is the number of years in the future.
In this case, the future payment (FV) is $20 million, the discount rate (r) is 6% (0.06 in decimal form), and the number of years (n) is 3.
Let's plug in the values and calculate the present value:
PV = 20,000,000 / (1 + 0.06)^3
PV = 20,000,000 / (1.06)^3
PV = 20,000,000 / 1.191016
PV ≈ $16,781,131.52
Therefore, the present value of the payment is approximately $16,781,131.52.