Appendix 1 EX 14-20 Present value of an annuity

Assume the same data as in Appendix 1 Exercise 14–19, except that the current interest rate is 12%.

Will the present value of your winnings using an interest rate of 12% be more than the present value of your winnings using an interest rate of 7%? Why or why not?


Answer:
No. The present value of your winnings using an interest rate of 12% is $42,376,650 ($7,500,000 × 5.65022), which is less than the present value of your winnings using an interest rate of 7% ($52,676,865; see Appendix 1 Ex. 14–19). This is because the winnings are affected by the higher interest rate.