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 percent?

Question

Quizplus · Accepted Answer

We need to calculate the present value of the MRP for three years at an interest rate of 7%.

PV = MRP / (1 + i)n
where PV is the present value, MRP is the future value, i is the interest rate, and n is the number of periods.

PV = 1000 / (1 + 0.07)1 + 1000 / (1 + 0.07)2 + 1000 / (1 + 0.07)3
PV = $2624.32

Therefore, the maximum price the firm should pay to purchase the equipment today is $2624.32. Option B is the correct answer.

Suppose a Piece of Capital Equipment Will Produce an MRP