Question
Joe got a job offer and he decided to rent his own apartment. He visited apartment A and was very satisfied. He has already paid
Joe got a job offer and he decided to rent his own apartment. He visited apartment A and was very satisfied. He has already paid a deposit of $1,000 on a 12-month apartment lease, but he still has NOT paid the first months rent and signed any contract yet. The monthly rent for apartment A is $1,000, and the deposit is refundable at the end of twelve months upon completion of the lease contract.
The next day, Joe finds a different apartment B that he likes just as well, but its monthly rent is only $900. If he rents this apartment, he would again have to pay a deposit of $900 and that is refundable at the end of the 12-month contract.
Joe now faces a dilemma - whether he should stay in the apartment A, or switch to the cheaper apartment (apartment B) and forego the deposit that he just paid. He decided to make a decision by comparing the present value of the FUTURE cash flows associated with the two apartment leases.
It is assumed that the discount rate is 2% per month. The rent for each month is paid at the beginning of the month in advance, and the deposit is returned at the end of twelve months.
Note: In the calculation, all the cash outflows are in negative values and all the cash inflows are in positive value. For example, the monthly rent of $900 is the amount you have to pay, so it should be -$900 in your calculation.
(a) What is the present value of the future cash flows (negative value for cash outflow and positive value for cash inflow) associated with apartment A?
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