You are negotiating to make a 7-year loan of $20,000 to Breck Inc.To repay you,Breck will pay $2,500 at the end of Year 1,$5,000 at the end of Year 2,and $7,500 at the end of Year 3,plus a fixed but currently unspecified cash flow,X,at the end of each year from Year 4 through Year 7.Breck is essentially riskless,so you are confident the payments will be made.You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year loan.What cash flow must the investment provide at the end of each of the final 4 years,that is,what is X?

Question

Quizplus · Accepted Answer

The correct answer is A because the present value of the cash flows at the end of each of the final 4 years must be equal to the present value of the loan. The present value of the cash flows at the end of each of the final 4 years is X * (1 - (1 + 0.08)^-4) / 0.08 = 2.83149 * X. The present value of the loan is $20,000. Therefore, 2.83149 * X = $20,000 and X = $2,831.49.

You Are Negotiating to Make a 7-Year Loan of $20,000