Sample Problem 6

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School

Middle Tennessee State University *

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Course

2410

Subject

Economics

Date

Feb 20, 2024

Type

docx

Pages

1

Uploaded by JudgeOxideToad35

Report
ECON 2420 Firms Charles L. Baum II Suppose you win a contest and are given the choice of the following prizes: Prize 1 : $100,000 to be received right away, with an additional payment of $100,000 to be received at the end of the next two years (e.g., $100,000 in 12 months and $100,000 in 2 years). Prize 2 : $275,000 to be received right away. Explain which prize you would choose and the basis for your decision. Assume your discount rate is 0.10 (or 10 percent). a) What is the present value of prize 1? The present value (PV) of prize 1 is: PV = 100,000 + 100,000 ( 1 + 0.10 ) + 100,000 ( 1 + 0.10 ) 2 PV = 100,000 + 100,000 1.1 + 100,000 ( 1.1 ) 2 PV = 100,000 + 100,000 1.1 + 100,000 1.21 PV = 100,000 + 90,909.09 + 82,644.63 PV = $ 273,553.72 . b) What is the present value of prize 2? Prize 2 is received right away, so its present value is $275,000. c) Which prize has the higher present value? The present value of prize 2 is larger ($275,000 versus $273,553.72).
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