Star Studios is looking to purchase a new building for its upcoming film product

Question

Star Studios is looking to purchase a new building for its upcoming film productions. The company finds a suitable location that has a list price of $1,480,000. The seller gives Star Studios the following purchase options: (FV of $1, PV of $1, FVA of $1, and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answers to 2 decimal places.)

1. Pay $1,480,000 immediately.

2. Pay $480,000 immediately and then pay $138,000 each year over the next 10 years, with the first payment due in one year.

3. Make 10 annual installments of $190,000, with the first payment due in one year.

4. Make a single payment of $2,180,000 at the end of five years.

1-a. Determine the present value for each option assuming that the company can borrow funds to finance the purchase at 7%.

1-b. Which option is the lowest-cost alternative for Star Studios?

Explanation / Answer

Alternative -1 Pay immediately Present value of cash outflows 1,480,000 Alternative -2 Down payment $ 480,000 Present value of down payment 480,000 Add: Present value of yearly instalment of $138,000 969312 ($138,000 each year for 10 year *Annuity factorof 7% i.e.7.024 Present value of cahs outflows 1,449,312 Alterntive-3 Yearly instalment of $190,000 Present value of yearly instalment of $190,000 1334560 ($190,000 each year for 10 year *Annuity factorof 7% i.e.7.024 Present value of cash outflow 1334560 Alternative 4- Payment at the end of 5 th year $2180,000 Present value of single payment at the end of 5 th year 1554340 ($2180,000 at the end of 5th year i.e. 0.713) Present valueof cash outflow 1554340 The best option is Option -3, as it has lowest present valueof cash outflow

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