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7 December, 15:36

Which cash flow would you rather pay, $425 today or $500 in two years if interest rates are 10 percent? Why?

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  1. 7 December, 15:41
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    The main goal is to compare these two based on the same terms; present values. Find the present value of $500 today by discounting it using 10% interest rate over two years.

    PV = FV / (1+r) ^n

    where FV = Future value = $500

    r = discount rate = 10% or 0.10 as a decimal

    n = total duration of investment = 2

    PV = $500 / (1+0.10) ^2

    PV = $500/1.21

    PV = $413.22

    Since you are basing the decision on what you would rather pay, you would want a lower pay amount. The $425 is already in its present value terms and it is more expensive. Therefore, you would prefer to pay $500 in two years.
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