Determine the difference in the present worth of the following two commodity contracts at an interest rate of 8% per year. Contract 1 has a cost of $10,000 in year 1; this cost will escalate at a rate of 4% per year for ten years. Contract 2 has a present cost of $80,520.

Difference = 4418.64

Explanation:

We first need to determine the present value of the contract 1. We already have the present value of contract 2.

The present value of contract 1 will be,

Present value = 10000 / (1.08) + 10000 * (1.04) / (1.08) ^2 +

10000 * (1.04) ^2 / (1.08) ^3 + 10000 * (1.04) ^3 / (1.08) ^4 + 10000 * (1.04) ^4 / (1.08) ^5 + 10000 * (1.04) ^5 / (1.08) ^6 + 10000 * (1.04) ^6 / (1.08) ^7 + 10000 * (1.04) ^7 / (1.08) ^8 + 10000 * (1.04) ^8 / (1.08) ^9 + 10000 * (1.04) ^9 / (1.08) ^10 +

10000 * (1.04) ^10 / (1.08) ^11

Present Value-Contract 1 = 84938.63563 rounded off to 84938.64

Difference = 84938.64 - 80520 = $4418.64