Q13SE_2 - Horngren'S Financial And Managerial Accounting

Question

S12A-13 Determining present value

Your grandfather would like to share some of his fortune with you. He offers to give

you money under one of the following scenarios (you get to choose):

1. \(8,750 per year at the end of each of the next six years

 

2. \)49,650 (lump sum) now

3. $100,450 (lump sum) six years from now

C H A P T E R 1 2

Requirements

1. Calculate the present value of each scenario using a 6% discount rate. Which scenario

yields the highest present value? Round to the nearest dollar.

2. Would your preference change if you used a 12% discount rate?

Step-by-Step Solution

Answer

No, the preference cannot be changed because in 12% present value is not high as compare to 6%.

Step 1: Definition of present value

Present value is basic tool of the finance that state that the amount invested in present have the more value than the amount invested in future.

Step 2: calculation of present value

1. Present value:

          $\begin{array}{c}\text{Present\hspace{0.17em}Value=\hspace{0.17em}Principal\hspace{0.17em}Amount×\hspace{0.17em}PV\hspace{0.17em}factor\hspace{0.17em}i=12\%,\hspace{0.17em}n=\hspace{0.17em}8}\\ \text{=\$8,750×\hspace{0.17em}\hspace{0.17em}}4.96764\\ \text{=\$43,4667}\end{array}$

       2. Present Value is $49,650

       3. Present Value:

          $\begin{array}{c}\text{Present\hspace{0.17em}Value=\hspace{0.17em}Principal\hspace{0.17em}Amount×\hspace{0.17em}PV\hspace{0.17em}factor\hspace{0.17em}i=12\%,\hspace{0.17em}n=\hspace{0.17em}8}\\ \text{=\$100,650×\hspace{0.17em}\hspace{0.17em}}0.40388\\ \text{=\$40,651}\end{array}$