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Chapter 6: Q21E (page 305)

Keith Bowie is trying to determine the amount to set aside so that he will have enough money on hand in 2 years to overhaul the engine on his vintage used car. While there is some uncertainty about the cost of engine overhauls in 2 years, by conducting some research online, Keith has developed the following estimates. Engine Overhaul Probability Estimated Cash Outflow Assessment $200 10% 450 30% 600 50% 750 10%

Instructions How much should Keith Bowie deposit today in an account earning 6%, compounded annually, so that he will have enough money on hand in 2 years to pay for the overhaul?

Short Answer

Expert verified

The present value of the expected cash flow will be $471.7.

Step by step solution

01

Computation expected cash flow

ExpectedCashFlow=Cashflow脳Probability=200脳10%+450脳30%+600脳50%+750脳10%=20+135+300+75=$530

02

Computation of present value

PresentValue=ExpectedCashflow脳PVFactor=530脳0.89000=$471.7

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