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Exercise 6-21
Keith Bowie is trying to determine the amount to set aside so that he will have enough money on hand in 4 years to overhaul the engine on his vintage used car. While there is some uncertainty about the cost of engine overhauls in 4 years, by conducting some research online, Keith has developed the following estimates.
| Engine Overhaul Estimated Cash Outflow |
Probability Assessment |
|||
| $300 | 10 | % | ||
| 500 | 30 | % | ||
| 750 | 50 | % | ||
| 990 | 10 | % | ||
(Use the tables below.)
How much should Keith Bowie deposit today in an account earning 8%, compounded annually, so that he will have enough money on hand in 4 years to pay for the overhaul? (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)
| Deposit amount | $ |
Expert Answer
The estimate for the cost of overhaul of engine is :- 300 * 10 % + 500 * 30 % + 750 * 50 % + 990 * 10 % = 30 + 150 + 375 + 99 = $ 654
Now, given i = 8 % and time = 4 years
We need $ 654 after 4 years so we need to find out the present value of $ 654 in order to know the amount to be deposited today :-
654 * PVIF ( 8 % , 4 years )
654 * 0.735 = $ 480 ( answer )
