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1. What is the present value of a stream of 2 annual cash flows of $100 beginning in one year time where the interest rate is 5% pa for the first year and 8 %pa for the second year.
2. Assuming an interest rate of 10%, what is the amount of money a person must be given now so that he is indifferent to receiving a stream of 5 annual payments of $50 each
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1. Ans: 100/(1+0.05) + 100/(1+0.08)^2
Work the arithmetic out yourself for the next step.
2. 5 annual payments of $50 discounted at the interest rate of 10% per annum:
Ans: 50/(1+0.1) + ... + 50/(1+0.1)^5
Rationale: Investor can use this same sum of money and re-invest it at the same rate of 10%, giving him the same amount of money after 5 years, therefore making him indifferent.
Work the arithmetic out yourself for the next step.
Edit: Typos
Edited by Paradise Lost 13 Mar `08, 5:34PM
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