(Q. 6 IN B) YOU DECIDE TO SELL YOUR CAR AND A FRIEND HAS OFFERED YO...

1. (Q. 6 in B) You decide to sell your car and a friend has offered you $1,000 now and four annual payments of $2,000, 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 $7,000. Assuming your friend will not default on the payments and the market interest rate is 8%, should you sell your car to your friend? A) Yes; present value is $7,134 B) Yes; present value is $7,624 C) No; present value is $6,134 D) No; present value is $6,624 Solution A The PV of the annuity payment of $2,000 for 4 years is: PV(at t=1) = 2,000 x PVIFA(8%,4) = 6,624.25 PV(at t=0) = 6,624.25/ (1.08) = 6,133.56 Finally add the initial payment $1000 today to the PV annuity at t=0 This is more than the $7,000 you would get today from the dealer. Therefore you would sell your car to you friend.