(a) Derek Lee Inc. has $600,000 to invest. The company is trying to decide betwe

Question

(a) Derek Lee Inc. has $600,000 to invest. The company is trying to decide between two alternative

uses of the funds. One alternative provides $80,000 at the end of each year for 12 years, and the

other is to receive a single lump sum payment of $1,900,000 at the end of the 12 years. Which alternative

should Lee select? Assume the interest rate is constant over the entire investment.

(b) Derek Lee Inc. has completed the purchase of new Dell computers. The fair market value of the

equipment is $824,150. The purchase agreement specifies an immediate down payment of $200,000

and semiannual payments of $76,952 beginning at the end of 6 months for 5 years. What is the

interest rate, to the nearest percent, used in discounting this purchase transaction?

Explanation / Answer

(a) Time diagram (alternative one): Formulas: PV–OA = R (PVF–OAn, i) $600,000 = $80,000 (PVF–OA12, i) PVF–OA12, i = $600,000 ¸ $80,000 PVF–OA12, i = 7.15 7.5 is present value of an annuity of $1 for 12 years discounted at approximately 9%. Future value approach Present value approach FV = PV (FVFn, i) PV = FV (PVFn, i) or $1,900,000 = $600,000 (FVF12, i) $600,000 = $1,900,000 (PVF12, i) FVF12, i = $1,900,000

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