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 Post subject: Macroeconomics: Present Value and Rate of ReturnPosted: Sat, 18 Oct 2008 18:49:06 UTC
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Joined: Sat, 18 Oct 2008 18:37:01 UTC
Posts: 4
I'm an accounting major and I've done extensive and much more complicated present value problems but for whatever reason this problem from my economics class is leaving me clueless so I was hoping that someone could help me out.

According to the problem: I am thinking of buying land that I can sell in 3 years for \$15,000. The asking price is \$8000 and my required rate of return is 25%. Based on my present value calculation: 15000/(1.25)^3 = \$7680, which is less than the cost, so I should not buy the land.

That's the easy part, but the next part of the question is causing me problems. It says "Suppose instead of \$8000, the seller is asking \$10000. What is the expected rate of return at this price?" I'm confused first off because in the first part MY required rate of return was 25% but this part seems to be asking for the seller's rate of return. In addition, I don't know how I would solve for that. Does anyone have any ideas?

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 Post subject: Posted: Sat, 18 Oct 2008 20:55:20 UTC
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Joined: Sun, 24 Jul 2005 20:12:39 UTC
Posts: 3690
Location: Ottawa Ontario
Rule: if a^x = b, then a = b^(1/x)

10000(1 + r)^3 = 15000
(1 + r)^3 = 15000/10000 = 3/2
1 + r = (3/2)^(1/3)
r = (3/2)^(1/3) - 1 = .14471424.... or ~14.47 %

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 Post subject: Posted: Sat, 18 Oct 2008 21:48:35 UTC
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Joined: Sat, 18 Oct 2008 18:37:01 UTC
Posts: 4
Thanks!

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