YOU DECIDE TO SELL YOUR CAR AND A FRIEND HAS OFFERED YOU $1,000 NOW...

7. You decide to sell your car and a friend has offered you $1,000 now and four annual

payments of $1,800, with the annual payments starting at the end of the second year.

Your other option is to sell the car to a dealer today for $6,450. Assuming your friend

will not default on the payments and the market annual interest rate is 8%, should you

sell your car to your friend?

A) Yes; present value of the friend’s offer is $6,520

B) Yes; present value of the friend’s offer is $6,624

C) No; present value of the friend’s offer is $5,134

D) No; present value of the friend’s offer is $5,624

E) Both options offer the same value

Answer A

The PV of the annuity payment of $1,800 for 4 years is:

PV (at t=1): $1,800 x PVIFA(8%,4) = $5,962

PV (at t=0) = $5,962/ (1.08) = $5,520

Finally add the initial payment $1,000 today to the PV annuity at t=0

$(5,520 + 1,000) = $6,520

This is more than the $6,450 you would get today from the dealer. Therefore you

should sell your car to you friend.