Answer (need work shown): 5013.98 Alicia is considering two offers-to-purchase t
ID: 2812810 • Letter: A
Question
Answer (need work shown): 5013.98
Alicia is considering two offers-to-purchase that she has received on a residential building lot she wishes to sell. One is a cash offer of $146,500. The other offer consists of three payments of $49,000—one now, one in six months, and one in twelve months. Which offer has the larger economic value if Alicia can earn 1.4% compounded quarterly on low-risk investments? How much more (in current dollars) is the better offer worth?
Answer (need work shown): The $145,000 cash offer is worth 521.25 more
Explanation / Answer
What amount 1.5 yrs from now is equivalent to $7000 due in 8 yrs if money can earn 5.2% compounded semiannually First we would calculate the present value of these $7000 due in 8 yrs with 2.6% (5.2%/2) of compounded semiannually PV = 7000*(1/(1.026^16) PV = 7000*(1/1.507849) PV = 7000*0.6632 PV = $ 4642.38 Now we would calculate FV of these $4642.40 in 1.5 yrs FV = $4642.40(1.026^3) FV = $4642.38*1.080046 FV = $5013.98 The above can also be calculated using the PV function in excel and than the FV function in excel PV(2.6%,16,0,7000) ($4,642.38) FV(2.6%,3,0,4642.38) ($5,013.98) 2 Alicia is considering two offers-to-purchase that she has received on a residential building lot she wishes to sell. One is a cash offer of $146,500. The other offer consists of three payments of $49,000—one now, one in six months, and one in twelve months. Which offer has the larger economic value if Alicia can earn 1.4% compounded quarterly on low-risk investments? How much more (in current dollars) is the better offer worth? Option 1 Cash flow now $146,500 Option 2 Time Cash outflow Discount factor @ 1.007 0 $49,000 1 6 $49,000 1 12 $49,000 1 1.4% compounded quarterly 1.4%/4 0.0035 per quarter Effective semi annual interest (1+0.0035)^2- 1 1.00701225 0.70% Using the PV function in excel we get present value of 2, $49000 to be received in future PV(G41,2,49000) ($96,978.75) Present Value of future $49000 $96,978.75 Cash flow today $49,000 Total cash flow $145,978.75 Cash offer now should be taken The offer is worth (146500-145978.75) 521.25