Suppose a piece of capital equipment will produce an MRP of $1000 per year for the next three years (beginning one year from now).What is the maximum price a firm will pay to purchase it today if the annual interest rate is 7%?

Question

Quizplus · Accepted Answer

We need to calculate the present value of the MRP of $1000 for 3 years starting one year from now. We can use the formula:

Present Value = Future Value / (1 + r)n

where r is the annual interest rate and n is the number of years.

For the first year, the MRP is not relevant since it's in the future. For the second year, the present value would be:

PV = $1000 / (1 + 0.07)2 = $847.46

For the third year, the present value would be:

PV = $1000 / (1 + 0.07)3 = $793.83

The total present value of the MRP for three years would be:

PV = $847.46 + $793.83 = $1641.29

Therefore, the maximum price the firm should pay today is the present value of the MRP, which is $1641.29. The only option close to this value is choice C ($2624.32), which is the correct answer.

Suppose a Piece of Capital Equipment Will Produce an MRP