You have a chance to buy an annuity that pays $2,500 at the end of each year for 3 years. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity

$6,744.83

Explanation:

the most you should pay for the annuity is the present value of the anniity.

first we have to determine the future value of the annuity

The formula for calculating future value = A (B / r)

B = [(1 + r)^n] - 1

FV = Future value  

P = Present value  

R = interest rate  

N = number of years  

$2,500 x {(1.055)^3 - 1 } / 0.055 = $7920.06

then we should find the present value of  $7920.06

present value is the sum of discounted cash flows

cash flow in year 1  and 2 = 0

cash flow in year 3 =  $7920.06

i = 5.5

present value = $6,744.83

To find the PV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.  

3. Press compute