June 6 MG 640 Model Quiz 1 Part 1(1)-1 (1)

June 6 MG 640 Model Quiz 1 Part 1(1)-1 (1) - Page 1 of 15...

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Page 1 of 15 Dr. Rawana _____________________________________________________________________________________ Name(last)……………………………………, (first)………………………………….. May 26, 2015 MG 640 Quiz 1 Part I _____________________________________________________________________________________ Discussion Problem 1. If the interest rate is 6% and cash flows are $4,000 at the end of year one and $5,000 at the end of year two, then the present value of these cash flows is Show all work. The use of the time line is useful in explaining your answer . TL (years): N = 2 0 i = 6% 1 2 PV FV ? 4,000 5,000 There are four unknown variables in this time value problem: a) PV = ? This is what you are required to determine b) Interest rate (6%) c) Number of years (2) d) FV1 =4,000 FV2 = 5,000 All variables are given except for PV. Therefore, the problem is to solve the present value for $4,000 and $5,000. To do so, convert the future into today’s equivalents as follows: TL (years): N = 2 Page 1 of 15
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Page 2 of 15 0 i = 6% 1 2 PV FV ? 4,000 5,000 = 4,000/(1+6%) 1 = 4,000/(1.06) 1 = 3,773.58 = (5,000)/(1+6%) 2 = 5,000/(1.06) 2 = 4,449.98 =$8,223.56 This sum is obtained by summing 3,773.58 and 4,449.98. Interpretation: The present value of the sum of $4,000 and $6,000 to be received in the future is equivalent as $8,223.56 today. This is the same as if we wait in the future and receive $4,000 and $6,000 when due.
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