Your grandmother would like to share some of her fortune with you. She offers to give you money under one of the following scenarios:

1. \$7,250 a year at the end of each of the next seven years

1. Calculate the present value of each scenario using a 6% interest rate. Which scenario yields the highest present value?

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

Present value is calculated by discounting discount rate to annual cash flow for the given period of time.The discount rate is also know as cost of equity. The cost of equity or discount rate is calculated by CAPM model.

1) The present value of each scenario using a 6% interest rate and the highest scenario yields present value is calculated below:

1) Scenario(1) : \$7,250 a year at the end of each of the next seven years

Net Present Value = \$7,250 *( PVIFA, 6% , 7 Years)

Net Present Value = \$48,750 *( PV 6% , 7 Years)

3) Scenario(3) : \$100,250 (lump sum) seven years from now

Net Present Value = \$100,250 *( PV 6% , 7 Years)

2) Lets check weather the preference will change if we used a 12% interest rate

1) Scenario(1) : \$7,250 a year at the end of each of the next seven years

Net Present Value = \$7,250 *( PVIFA, 12% , 7 Years)

Net Present Value = \$48,750 *( PV 12% , 7 Years)

3) Scenario(3) : \$100,250 (lump sum) seven years from now

Net Present Value = \$100,250 *( PV 12% , 7 Years)

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