A person runs up to you, short $1500. He offers to pay you $400 a year for the next 15 years if you spot him now. You try to do a rough calculation to determine if its worth it assuming you trust his credit worthiness as much as you trust the U.S. dollar.

1) With the prevailing 1 year treasury rate at 3.20%, what is the value of the agreement (NPV) and should you take it?

 

2) Changing the story, the person is not broke and a gambling addict. Instead, being very superstitious, he asks you to stand near him during a game as good luck. As a reward, he decides to offer you $50 a year in perpetuity. You decide to sell this agreement to another student. What would be the fair value of the sale assuming the same 1 year treasury rate at 3.20%?

Answer rating: 100% (QA)

To calculate the net present value NPV of the agreement we need to discount the future cash flows us... View the full answer