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Chapter 26: Q19RQ (page 1464)

How is the present value of a lump sum determined?

Short Answer

Expert verified

Answer

PV=FV11+r°

Step by step solution

01

Meaning of Present Value

Present value compares the acquiring control of a future dollar to that of a current dollar. It is a money-related calculation that gauges the worth of a future amount of cash or stream of installments in today's dollars adjusted for interest and inflation.

02

Determination of the present value of a lump sum.

The following formula is used to calculate the present value (PV) of a lump sum: PV factor for future value for interest rate and time.

In which the future value FV is divided by a factor of 1 + I for each interval between present and future dates.

To calculate the PV, enter these figures into the present value calculator:

FV stands for the sum of future values.

“n” in the formula is the number of time periods (years).

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Most popular questions from this chapter

Henry Co. is considering acquiring a manufacturing plant. The purchase price is \(1,200,000. The owners believe the plant will generate net cash inflows of \)325,000 annually. It will have to be replaced in six years. Use the payback method to determine whether Henry should purchase this plant. Round to one decimal place.

Using the time value of money Helen wants to take the next four years off work to travel around the world. She estimates her annual cash needs at $31,000 (if she needs more, she will work odd jobs). Helen believes she can invest her savings at 10% until she depletes her funds. Requirements

  1. How much money does Helen need now to fund her travels?
  2. After speaking with a number of banks, Helen learns she will only be able to invest her funds at 6%. How much does she need now to fund her travels?

S26-2 Using payback to make capital investment decisions

Carter Company is considering three investment opportunities with the following payback periods:

Project A

Project B

Project C

Payback period

2.7 years

6.4 years

3.8 years

Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal.

Congratulations! You have won a state lottery. The state lottery offers you the following (after-tax) payout options:

Option #1: \(12,000,000 after five years

Option #2: \)2,150,000 per year for five years

Option #3: $10,000,000 after three years

Assuming you can earn 6% on your funds, which option would you prefer?

Using ARR to make capital investment decisions Refer to the Henry Hardware information in Exercise E26-20. Assume the project has no residual value. Compute the ARR for the investment. Round to two places.

Henry Hardware is adding a new product line that will require an investment of \(1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of \)310,000 the first year, \(270,000 the second year, and \)240,000 each year thereafter for eight years.
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