Question

Determine the difference in the present worth of the following two commodity contracts at an interest rate of 8% per year. Contract 1 has a cost of $10,000 in year 1; this cost will escalate at a rate of 4% per year for ten years. Contract 2 has a present cost of $80,520.

Answer 1

Answer:

Difference = 4418.64

Explanation:

We first need to determine the present value of the contract 1. We already have the present value of contract 2.

The present value of contract 1 will be,

Present value = 10000/(1.08)  +  10000*(1.04)/(1.08)^2  +  

10000*(1.04)^2/(1.08)^3  +  10000*(1.04)^3/(1.08)^4  +  10000*(1.04)^4/(1.08)^5  +  10000*(1.04)^5/(1.08)^6  +  10000*(1.04)^6/(1.08)^7  +  10000*(1.04)^7/(1.08)^8  +  10000*(1.04)^8/(1.08)^9   +  10000*(1.04)^9/(1.08)^10  +

10000*(1.04)^10/(1.08)^11

Present Value-Contract 1 = 84938.63563 rounded off to 84938.64

Difference = 84938.64 - 80520  =  $4418.64