NPV Simes Innovations, Inc., is negotiating to purchase exclusive rights to manu
ID: 2617501 • Letter: N
Question
NPV Simes Innovations, Inc., is negotiating to purchase exclusive rights to manufacture and market a solar-powered toy car. The car's inventor has offered Simes the choice of either a one-time payment of $1,500,000 today or a series of 5 year-end payments of $385,000 a. If Simes has a cost of capital of 9%, which form of payment should it choose? b. What yearly payment would make the two offers identical in value at a cost of capital of 9%? c. What would be your answer to part a of this problem if the yearly payments were made at the beginning of each year? d. The after-tax cash inflows associated with this purchase are projected to amount to $250,000 per year for 15 years. Will this factor change the firm's decision about how to fund the initital investment? a. If Simes has a cost of capital of 9%, the present value of the annuity is (Round to the nearest dollar)Explanation / Answer
a) step 1: Calculation of present value of series payment
Present value of Annuity = A*[(1-(1+r)-n)/r]
Where
A - Annuity payment
r - rate per period
n - no. of periods
Present value of Annuity = 385,000*[(1-1.09-5)/.09]
= 385,000 * 3.890
= $1,497,650
Analysis: Since the present value of series payment is lower than the one time payment, series payment is preferable.
b) To make the two offers identical, present value of series payment should be $1,500,000
1,500,000 = A*[(1-1.09-5)/.09]
1,500,000 = A * 3.890
A = 1,500,000 / 3.890
Annuity Payment = $385,604.11
c) When the payments are made at the begining of each year
Present value of Annuity = A*[(1-(1+r)-n)/r]*(1+r)
= 385,000*[(1-1.09-5)/.09]*1.09
= 385,000 * 3.890 * 1.09
=$1,632,438.50
Analysis: Since the present value of series payment is higher than the one time payment, one time payment is preferable.
d) Present value of future bdenefits from the purchase is calculated as
Present value of Annuity = 250,000*[(1-1.09-15)/.09]
= 250,000 * 8.0607
= $2,015,175
Analysis: Since the present value of future benefit is higher than the two offers, it does not change the firm's decision about how to fund the initial investment.
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