To calculate: The best stream for present value of cash flow
Introduction:
If single cash flow put in an investment today which pays us
Explanation of Solution
Calculation of present value of cash flow stream at 7% compounding rate
Contract 1 | Contract 2 | Contract 3 | ||||
Year | Cash in flow | Present Value | Cash in flow | Present Value | Cash in flow | Present Value |
1 | 3,000,000 | 2,803,738 | 2,000,000 | 1,869,159 | 7,000,000 | 6,542,056 |
2 | 3,000,000 | 2,620,316 | 3,000,000 | 2,620,316 | 1,000,000 | 873,439 |
3 | 3,000,000 | 2,448,894 | 4,500,000 | 3,673,340 | 1,000,000 | 816,298 |
4 | 3,000,000 | 2,288,686 | 5,500,000 | 4,195,924 | 1,000,000 | 762,895 |
Total PV | 10,161,634 | 12,358,739 | 8,994,688 |
Table (1)
Working Note for present value:
Present value for year 1 and contract 1
Present value for year 2 and contract 1
Present value for year 3 and contract 1
Present value for year 4 and contract 1
Present value for year 1 and contract 2
Present value for year 2 and contract 2
Formula to calculate present value for year 3 and contract 2
Formula to calculate present value for year 4 and contract 2
Formula to calculate present value for year 1 and contract 3
Formula to calculate present value for year 2 and contract 3
Formula to calculate present value for year 3 and contract 3
Formula to calculate present value for year 4 and contract 3
So, the contract 2 is the best option as total present value is highest for contract 2.
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