Good Guys will pay you $2,500 a year for 10 years in exchange for $31,300 today.What interest rate will you earn on this annuity?

Question

Quizplus · Accepted Answer

This is a case of annuity where we have to find out the interest rate. We can solve this using the Present Value of Annuity (PVA) formula.

PVA = Payment x (1 - (1 + r)^-n)/r

Where,
PVA = Present Value of Annuity
Payment = $2,500
r = Interest rate per period
n = Number of periods

Given that the Present Value (PV) of annuity is $31,300 and the payment is $2,500 for 10 years.

PV = Payment x (1 - (1 + r)^-n)/r

$31,300 = $2,500 x (1 - (1 + r)^-10)/r

Now, solving for r using trial and error method or using Excel or any calculator that supports the IRR function, we get:

r = 3.89%

Hence, the answer is B, 3.89 percent.

Good Guys Will Pay You $2,500 a Year for 10