An art collector has the opportunity to invest in paintings. The investment requ

Question

An art collector has the opportunity to invest in paintings. The investment required an initial outlay of $2 million today. The collector is certain that he will be able to sell the paintings for $2.18 million 1 year from now. He also has the opportunity to invest in bank certificates of deposit which pay 10% per year.

a. What is the future value of the $2 million in 1 year if the collector elects to purchase a bank certificate of deposit? Is the investment in the paintings a good investment?

b. What is the rate of return for the investment in paintings?

c. For the paintings described, what is the present value of the future cash flow the collector would receive if he sold the paintings 1 year from now? What is the value of the paintings to the collector?

Explanation / Answer

(a) Calculating Future Value of bank certificates of deposit: Future Value = Present Value * (1+r)t Future Value = $2,000,000 *(1+0.10)1 Future Value = $2,000,000 * (1.10)1 Future Value = $2,000,000 * 1.10 Future Value = $2,200,000 No, the Investment in paintings are not a good investment, because Investment in paintings has got a return of $2,180,000 after 1 year, but the Investment in Bank Certificates will give you return of $2,200,000. Thus, Investment in Paintings are not a good investment. Calculating Future Value of Bank Certificates of Deposit (FV): (Using Ms-Excel "FV" Function): Interest Rate (Rate)                                                    10% Number of Periods (Nper)                                             1 Present Value of Investment in Paintings (PV)            -2,000,000 Future Value of the $2,000,000 (FV)                     $2,200,000 (b) Calculating the Rate of Return for the Investment in Paintings:       Calculating Rate of REturn for the Investment in Painting (Rate):       (Using Ms-Excel "Rate" Function)       Number of Periods (Nper)                                       1       Present Value of Investment in paintings (PV)         -2,000,000       Future Value of Present INvestment (FV)                  2,180,000       Rate of Return on Investment (Rate)                        9.00%        (c) Calculating Present Value of the Future Cash flows       Calculating Present Value of Future Cash Flow (PV):       (Using Ms-Excel "Rate" Function):           Interest Rate (Rate)                                                   9%       Number of Periods (Nper)                                          1       Future Value of Investment (FV)                           -$2,180,000       Present Value of Future Cash flows (FV)            $2,000,000 (b) Calculating the Rate of Return for the Investment in Paintings:       Calculating Rate of REturn for the Investment in Painting (Rate):       (Using Ms-Excel "Rate" Function)       Number of Periods (Nper)                                       1       Present Value of Investment in paintings (PV)         -2,000,000       Future Value of Present INvestment (FV)                  2,180,000       Rate of Return on Investment (Rate)                        9.00%        (c) Calculating Present Value of the Future Cash flows       Calculating Present Value of Future Cash Flow (PV):       (Using Ms-Excel "Rate" Function):           Interest Rate (Rate)                                                   9%       Number of Periods (Nper)                                          1       Future Value of Investment (FV)                           -$2,180,000       Present Value of Future Cash flows (FV)            $2,000,000

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