A student owes the bookstore $900 and doesn't have the money to pay the full balance. The college offers two payment options:
1. Pay $300 today and $700 in two years.
2. Pay $1,200 three years from today.
Assuming the cost of money is 8% compounded annually, which alternative should be selected?
Present value is a measure of time value of money which shows the time preference of money which means that the money in future is less preferred over the money in present so future money should be compensated with some interest.
Answer and Explanation: 1
Here we need to use the present value formula to compare these two options
PV = C/(1+r)^p
C = cashflows = 300 and 700
r = 8%
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fromChapter 8 / Lesson 3
Learn how to find present value of annuity using the formula and see its derivation. Study its examples and see a difference between Ordinary Annuity and Annuity Due.