Question

You are planning to place your money in safe government securities, which currently offer a 4% riskless rate of return. Before making this investment, an entrepreneur approaches you and asks you to purchase her new business venture, FastDrop, a delivery service for legal documents that would produce a single cash inflow of $80,000 at the end of the year. You have determined that 6% is an appropriate risk premium for this investment. How much would you be willing to pay for Fast Drop? Please enter only the number of your answer. Do not use the dollar sign or commas.

Answer 1

Answer:

72727

Explanation:

The first step is to determine the opportunity cost.

Opportunity cost = Risk free rate + Risk Premium

10% = 4% + 6%

The second step, given the opportunity cost of 10%, is to determine that the economic value of this investment is:

80,000/1.10 = 72,727

Answer 2

Answer:

$72,727.27 ≈ 72727.27

Explanation:

we can use the present value formula to calculate the current value of FastDrop:

present value = future value / (1 + required interest rate)ⁿ

• future value = $80,000
• n = 1
• required rate of return = risk free rate + risk premium = 4% + 6% = 10%

present value = $80,000 / (1 + 10%) = $80,000 / 1.1 = $72,727.27

*the required rate of return (RRR) = risk free rate + [β x (market rate of return - risk-free rate of return)]. In this case we were given the risk premium.