Explainning how I got that montly interest rate... Let's call it x...

x^12=1,08
x=1,001203239

Wired Guy and Tranza, your answers are more than the total amount of payments. When I use the calculator located at the lower left corner of this page: http://www.uic.edu/classes/actg/actg500/pfvatutor.htm I get them both coming in around 275,000 dollars. If I am using it right, that is.

Hi Rick check out my answer this is the only answer you should check, and you can take off the $20 from my next wire ;o)

Well NPV (Net Present Value) is simply a formula that puts all future income into present value - as you correctly pointed out, your question revolves around the time value of money.

So what the formula is doing is essentially, for A:

NPV = $2,250/(8%/12) + $2,250/(8%/12)^2 + $2,250/(8%/12)^3 + ...... + $2,250/(8%/12)^480

Does that make sense?

Is it possible that your answer is correct yet only off by a decimal point?

I'm just computing the calculations based on my acturial sciences courses I did. But look at it this way:

$2250 * 12 months * 40 years = $1,080,000
$2750 * 12 months * 18 years = $594,000

No interest in the above calculated and contract A is worth almost twice as much. Now factor that contract A is compounding interest for twice as long and it makes sense to me that Contract A is much more valuable and by a factor of 3-4 times. Seems to make sense to me.

WG

nop, it is the present value, if you want to know the value in the end of the period you need to use a deferent Formula, but it doesn't mater any way, because you need to know what is the best offer, and the best way to check it out is by using the present value of the offer.

there is no logic in checking what will be the value of a in another 40 years and to comper it to the value of b in another 18 years.

You need to bring bouth offers to the same date, and that is why you are useing the present value formula.

you can trust me, I have an MBA from Wharton

I would have thought the opposite. But you are a good businessman. You are saying that you would take contract A even though you'd get 6,000 dollars a year less over 18 years?

this is a funny thread :1orglaugh

Uhm.... Impossible....

Disconsider the interest: 2250 * 12 * 40 = 1,080,000
2750 * 12 * 18 = 594,000

Right! And if a guy is giving you 1.08 Million dollars over 40 years, what is he really giving you???? That my friends is the question.

Rick - did you see my explanation?

This is not the answer read my last respond and you will understand why my first one was the only one corect up t now and all the others are just bullshit :321GFY

On A: you'll have 1,460,541.37
On B: 677,872.51


But, if you question is the oposite: I have now 1.08 million, how much have I earned each month in the past 40 years with a 8% annual interest I'd have to do the math again.....

I don't understand your formula but that is only because of my poor math skills. You certainly seem to be the only one that truely understands the question. So, if...

NPV A: $323,595.88
NPV B: $314,299.14

Then I would go with B because it comes in 18 years rather than 40 years. I sure hope you are right or you are costing me the differnce plus the 20 bucks I am sending you now. So, what's your addy?

OK
A IS THE ANSWER THE MONEY IS BETTER IN YOUR POCKET. GET THE MONEY IN AND INVEST IT YOUR WAY. 40 YEARS IS A JOKE THAT WILL NEVER COME TO FRUITION. EVEN BANKS DON"T GO OUT LONGER THAN 30 YEARS.

REMEMBER CASH IS KING AND FUCK EVERYTHING ELSE

Hi Rick as you said So here it is again just for you

The numbers that you see in my formula are present value, if you want to know the value in the end of the period you need to use a deferent Formula, but it doesn't mater any way, because you need to know what is the best offer, and the best way to check it out is by using the present value of the offer.

there is no logic in checking what will be the value of a in another 40 years and to comper it to the value of b in another 18 years.

You need to bring bouth offers to the same date, and that is why you are useing the present value formula.

you can trust me, I have an MBA from Wharton

This can be confirmed using Excel's built in formula for present value:

PV(0.08/12,480,2250) = $323,595.88

PV(0.08/12,216,2750) = $314,299.14

Thus the 40 year option has a higher present value by $9,296.74.

Ahhh, now I see what you mean, I was looking dollar for dollar value. Let me think about this while I eat, check back in an hour...

WG

Are you telling me that BlueDesignStudios is wrong? If a bank wanted to buy the contract, what would they pay if they wanted an 8% return?

You've almost got it :)

You would pick A though - what the NPV formula does is puts both income series into *present* values - so you can just compare one value to the other - without worrying about the time value of money.

I thought this question was a theoritical example? If this is a real life situation, then you have to take into account other factors:
- inflation
- interest rate risk
- & other more complex factors

If your question does have some real world significance, then I would like to explain my answer fully to you, to make sure you understand :)

Well, then with mine from USC I feel compelled to point out that you should advise our dear Rick of the sensitivity of Present Value to that discount rate...:-)

Cut that inflation/discount rate in half to 4% (as it probably should be) and A is a dramatic winner...at 8% it's close to a wash, as was mentioned...

Rick--what are you paying to get this deal? Perhaps the boys can work out the NPV and internal rate of return for ya...they seem to be chompin' for some math

This is a very real situation. One advantage of the longterm option is that the guy is more likely to default and return my assett! What's your ICQ?

for a they would have paid 26,830.38
and for B they would have paid 25,772.68

not a penny less and not a penny more

I am selling something. Both are actually leases with a 500 dollar buyout at the end of the contract. The question is which offer to take for my assett.

Not possible. Neither of those options equal one years worth of payments. Think about it.

All the other parameters are not relevant due to the fact that he will get 8% only on the ropi but not on the $ so the numbers aren't for real any way :thumbsup

It would be 10 times as much or more.

I agree with Blue...A is the better option by a slim margin at 8%...but as I said, realistically inflation won't eat 8% of your yearly cash flows in the future...more likely 3-4% (long term bond rates)...which means A gets REALLY attractive...don't get suckered into B from the buyer, IMO...

So what does Blue's numbers come to at 4%?

My ICQ is: 99438864

I just added you though you dont' seem to be on ?

Option A = $538,356.76
Option B = $422,948.28

this is for 40 months and 18 months of 8% per month.
there is no deferance in the end if you change it to 40 years and 18 years and 0.666% per month.
the decition will stay the same A is better then B

if you change it to 40 years and 18 years with an 8% per year then it is

NPV A: $323,595.88
NPV B: $314,299.14

but the decition that you need to take stay the same

You must have take Marketing classes in your second year...the 8% is a discount rate...he's not "earning" it...you use it to bring back cash flows into today's dollars...it's a proxy for inflation...get with the program...a string of payments of 27000 per year for 40 years is not worth less than one annual payment...

Correct me if I'm wrong Blue..but at 4% it's A=$534K to b's=$417K...

So, I'd def go with the longer term...

Yeah rastakit - I get:

NPV A: $538,356.76
NPV B: $422,948.28

So once again NPV A seems a lot higher, $115,408.48 better off

however these numbers aren't really justified (i.e the 8% to 4%)

the discount rate in this case is the same as the earnings. there is no info about inflation.
and as I explaind before the calculation were for 40 month and 18 month on an 8% per month that's why it is coming to about 20k and not 300k

Blue you win the bet either way. But, everyone is I'm sure learning a lot here. I know I am. Which is a better offer? The question is now, what percentage do you use to determine the better deal? If you were selling something and had to choose between the two contracts, how can you tell?

A is better

These numbers are correct and can be verified by this tool:
http://www.pheaa.org/Forms_and_FAQs/form/fm2.shtml

Assuming the base amount saved per period was 27k/33k respectively, with interest computed annually at 8%.

This only indicates the total dollar amount of the contracts though over 40 years and 18 years respectively.

Say that contract A was 18 years as well, using the same math we figure contract A would be worth $1,011,156. So at the end of 18 years contract B is only worth about $200,000 more.

So at the end of 18 years, Contract B is worth more at $1.2MM by 200k over Contract A. So if you feel you can take that $1.2 MM at the end of 18 years and turn it into an additional $5.7 million over 22 years then Contract B is worth more. Otherwise, contract A will make $6.9MM over the course of the 40 year tenure and to me, I would rather pick contract A.

WG