Exercise-2 (Computation of present value of a single sum )
Posted in: Capital budgeting techniques (exercises)
An employee plans to retire in 15 years. After retirement, he will need an amount of $20,000 to start a small business.
Required: Compute the amount that employee needs to invest today to have an amount of $20,000 upon his retirement assuming an interest rate of:
- 10% compounded annually.
- 14% compounded annually.
Solution:
(1) Investment required at 10% interest rate:
PV = FV × 1/(1 + r)n
= $20,000 × 1/(1 + 10%)15
= $20,000 × 0.239*
= $4780
*Value of 1/(1 + 10%)15 from present value of $1 table: 15 periods; 10%.
(1) Investment required at 14% interest rate:
PV = FV × 1/(1 + r)n
= $20,000 × 1/(1 + 14%)15
= $20,000 × 0.140*
=$2,800
*Value of 1/(1 + 14%)15 from present value of $1 table: 15 periods; 14% interest rate.
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