Present Value of a Lump Sum
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P3-7. Gina Coulson has just contracted to sell a small parcel of land that she inherited a few years ago. The buyer is willing to pay $24,000 at closing of the transaction or will pay the amounts shown in the following table at the beginning of each of the next five years. Because Gina doesn't really need the money today, she plans to let it accumulate in an account that earns 7 percent annual interest. Given her desire to buy a house at the end of five years after closing on the sale of the lot, she decides to choose the payment alternative?$24,000 lump sum or mixed stream of payments in the following table?that provides the highest future value at the end of five years.
Mixed Stream
Beginning of Year (t) Cash Flow (CFt)
1 $ 2,000
2 4,000
3 6,000
4 8,000
5 10,000
a. What is the future value of the lump sum at the end of year 5?
b. What is the future value of the mixed stream at the end of year 5?
c. Based on your findings in parts (a) and (b), which alternative should Gina take?
d. If Gina could earn 10 percent rather than 7 percent on the funds, would your recommendation in part (c) change? Explain.
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