Exam 4: The Time Value of Money Part 2

Your neighbor owns a perpetuity of $100 per year that has a discount rate of 6% per year.He offers to sell to you all but the next 20 cash flows (the first to be received one year from today)for $500.In other words,he keeps the first 20 cash flows of his perpetuity and you get all of the rest.Is this a good price for you if the appropriate discount rate is 6%?

If you borrow $5,000 at an annual interest rate of 9.0% for six years,what will your repayment(s)be if this is a discount loan?

When solving for present value,we use the term compounding of cash flows rather than the term discounting of cash flows.

The present value of a lottery received as an annuity due is less than the present value of a lottery whose cash flows are received as an ordinary annuity.(Assume that the interest rate used to discount the cash flows is positive and equal between the two choices and that the magnitude and number of cash flows are equal for the two choices.Only the timing of the cash flows differs between the two choices. )

Given a positive interest rate and a positive cash flow,an ordinary annuity always has a greater present value than an annuity due of the same size and number of cash flows.