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Hi
I hope you can clarify the following multiple choice question for me:
Q: An investor has a cost of capital of 10%. she is due to receive a five year annuity starting in 3 years time of $7000 pa.
What lump sum would you need to offer today to make her indifferent between the annuity and your offer?A: $21924
They included 10% annuity factor from years 3-7 inclusive= 4.868-1.736=3.132 x $7000 = $21924
I dont understand why we dont use the annuity factor of 10%for years 3 & 5, why do we use the 7th year’s annuity factor??
The first receipts is in 3 years time. Since there are 5 receipts in total, the last receipt is in 7 years time.
The 7 year annuity factor is the total for years 1 to 7.
Since we need the factor for years 3 to 7, we subtract the 2 year annuity factor (which is the total for years 1 to 2).
This leaves us with the total for years 3 to 7.It will help you to watch the relevant free Paper F2 lecture on here, because this is revision of Paper F2.
Thank you john, Ill listen and hope it will clarify it!
thanks for your answer, most clear 😉
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