Life for Kids Company, a small producer of plastic swimming toys, wants to determine the most it should pay to purchase a particular ordinary annuity. The annuity consists of cash flows of $700 at the end of each year for 5 years. The firm requires the annuity to provide a minimum return of 8%. How much should Life for Kids Company prepare today? Post your answer and show the calculation.
To determine the most that Life for Kids Company should pay to purchase the particular ordinary annuity, we need to calculate the present value of the annuity.
The present value (PV) of an annuity formula is:
PV = C * [1 - (1 + r)^(-n)] / r
Where:
PV = Present value of the annuity
C = Cash flow per period
r = Discount rate (or required minimum return)
n = Number of periods
In this case:
C = $700 (cash flow per year)
r = 8% (discount rate or required minimum return)
n = 5 years (number of years)
Using the formula, we can calculate the present value as follows:
PV = $700 * [1 - (1 + 0.08)^(-5)] / 0.08
Now let's do the calculation:
PV = $700 * [1 - (1.08)^(-5)] / 0.08
PV = $700 * [1 - 0.68058] / 0.08
PV = $700 * 0.31942 / 0.08
PV = $2,236.47
Therefore, Life for Kids Company should prepare $2,236.47 today to purchase the particular ordinary annuity that provides a minimum return of 8%.