Question

Doris's Fashions has just signed a $2.2 million contract. The contract calls for a payment of $0.6 million today, $0.8 million one year from today, and $0.8 million two years from today. What is this contract worth today if the firm can earn 8.2 percent on its money

Answer 1

Answer:

$2.02 million

Explanation:

We need to calculate the present value of Doris's contract given the following three cash flows:

Year 0 $0.6 million

Year 1 $0.8 million

Year 2 $0.8 million

interest rate = 8.2%

present value (in million) = $0.06 + ($0.8 / 1.082) + ($0.8 / 1.082²) = $0.6 + $0.74 + $0.68 = $2.02 million

*present value formula = future value / (1 + r)ⁿ

Answer 2

The contract worth today is $2.02 million.

Calculation of the today worth of the contract:

We know that

present value formula = future value / (1 + r)ⁿ

So,

= $0.06 + ($0.8 / 1.082) + ($0.8 / 1.082²)

= $0.6 + $0.74 + $0.68

= $2.02 million

hence, we can conclude that The contract worth today is $2.02 million.

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