An answer of $4,465 results from discounting the note receivable using the present value of an annuity of $1,000 and a 6% rate for 4 years and then adding the $1,000 down payment at its undiscounted value of $1,000. However, the question asks only for the present value of the note receivable, not the present value of the entire transaction.
An answer of $4,212 results from using the present value of an annuity factor for 6% for 5 years. However, the note is for four years.
An answer of $2,940 results from discounting the entire amount of the note ($4,000) at 8% for four years. This is incorrect for two reasons: (1) The full principle of the note ($4,000) is assumed to be paid at the maturity date in four years. However, the note calls for annual principle payments of $1,000. (2) The discount rate used is 8%. However, the discount rate to be used is 6%.
The note calls for four annual payments of $1,000. This is an ordinary annuity, since the payments are due at the end of each period. Therefore, the factor in the present value of an annuity table can be used as it is given, without adjustment. The present value of a four-year ordinary annuity of $1,000, discounted at 6%, is $1,000 × 3.465, or $3,465.
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