How much would an investor be willing to pay today for an investment that returns $1000 every year at year-end for five years if he wants to earn a 10% annual return on the investment?

Question

Quizplus · Accepted Answer

To calculate the present value of the investment, we need to use the formula for the present value of an annuity:

PV = C * [(1 - (1 + r)^-n) / r]

Where:
PV = present value
C = cash flow per period
r = discount rate
n = number of periods

Using the given values:
C = $1000
r = 10% = 0.1
n = 5

PV = $1000 * [(1 - (1 + 0.1)^-5) / 0.1]
PV = $1000 * [(1 - 0.6209) / 0.1]
PV = $1000 * [3.791]
PV = $3,791

Therefore, an investor would be willing to pay $3,791 today in order to earn a 10% return on an investment that pays $1000 per year for five years. The closest answer choice is B.

How Much Would an Investor Be Willing to Pay Today