According to the theory underlying the present-value formula, would a rational individual prefer to receive (a) $75 one year from now, (b) $85 two years from now, or (c) $90 three years from now, or would he be indifferent between all three choices? Assume that the relevant annual market interest rate is 20 percent and will remain at 20 percent for the next three years?
A)He will prefer $75 one year from now.
B)He will prefer $85 two years from now.
C)He will prefer $90 three years from now.
D)He will be indifferent between all three choices.

Question

Quizplus · Accepted Answer

The present-value formula states that the value today of a future payment is equal to the future payment divided by one plus the interest rate raised to the power of the number of years until the payment is received. Using this formula, we can calculate the present value of each option:

a) $75 one year from now has a present value of $62.50 [(75/1.20^1)]
b) $85 two years from now has a present value of $59.17 [(85/1.20^2)]
c) $90 three years from now has a present value of $58.05 [(90/1.20^3)]

Therefore, a rational individual would prefer to receive $75 one year from now because it has the highest present value.

According to the Theory Underlying the Present-Value Formula, Would a Rational