Exercise 1 A cash flow of $500,000 may be received by Cynthia Bennett Company in
ID: 2417708 • Letter: E
Question
Exercise 1
A cash flow of $500,000 may be received by Cynthia Bennett Company in one year, two years, or three years, with probabilities of 30%, 60%, and 20%, respectively. The rate of interest on default risk-free investments is 8%.
Required:
What is the expected present value of Cynthia Bennett' cash flow? Round your answers to the nearest whole dollar.
NOTE: Be sure to show all your calculations. This has the possibility of partial credit. Incorrect answers without calculations will automatically result in zero points.
Explanation / Answer
Expected present value ($) = 30% x [500,000 / (1.08)] + 60% x [500,000 / (1.08)2] + 20% x [500,000 / (1.08)3]
= 30% x 462,963 + 60% x [500,000 / 1.1664] + 20% x [500,000 / 1.2597]
= 30% x 462,963 + 60% x 428,669 + 20% x 396,920
= 138,889 + 257,201 + 79,384
= 475,474
Disclaimer: The probabilities add up to 110% and not 100%. Question has been solved only on basis on data provided without changing any of the probabilities to match up to 100%.
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