Fernando Zapetero, who recently won $20,000 in the lottery, wants to buy a car in five years. Fernando estimates that the car will cost $32,210 at that time. His cash flows are displayed in Figure 4.7.

What interest rate must he earn to be able to afford the car? Cash Flows for Purchase of Car

The ratio of purchase price to initial cash is:

He must earn an interest rate that allows $1 to become $1.6105 in five years. Table A.3 tells us that an interest rate of 10 percent will allow him to purchase the car.

We can express the problem algebraically as:

where r is the interest rate needed to purchase the car. Because $32,210/$20,000 = 1.6105,we have:

The table, a spreadsheet, or a calculator can be used to solve for r.

Transcribed Image Text:

Cash inflow Cash outflow $20,000 0 5 Time -$32,210