Vincent Smudge's paintings are unappreciated now.Nobody is willing to pay anything to have them on the walls.In 5 years Smudge's work will gain enduring popularity.People will suddenly be willing to pay $1,000 a year to have an original Smudge on their walls and will continue to be willing to do so ever after.If investors realize that this is the case and if the interest rate is and always will be r, a painting by Smudge will currently be worth about

Question

Quizplus · Accepted Answer

This problem requires the use of the formula for present value of a future cash flow, which is: PV = CF/(1+r)^n. In this case, the future cash flow is $1,000 per year, n is 5 years, and r is the interest rate. Using the formula, we can rewrite the expression as: PV = $1,000/(1+r)^5. Therefore, Smudge's painting will currently be worth approximately $(1,000/r)[1/(1+r)^5]. This matches choice A.

Vincent Smudge's Paintings Are Unappreciated Now