Your company is considering a payment plan to pay for a large piece of equipment

Question

Your company is considering a payment plan to pay for a large piece of equipment. There are two payment options available: Make a lump sum payment of $500000, or Make 25 annual payments of $50000 each, with the first payment to be made today. The key to make the right choice is to compute the present value of the 25 installment payment, and then compare the PV to the lump sum payment. You would then choose the lower amount because you'll be paying less. What's the present value of the installment payment plan, assuming that the proper annual discount rate is 8.20%?

Hint: The correct answer would be

Please show me how to solve this problem.

Explanation / Answer

Solution:

Option 1:

Lumpsum payment =$5,00,000

Option 2:

25 equal annual installment =$50,000 each

Discount rate= 8.20%

Present value of 25 installment $50,000/(8.20%,PVAF,0-24 years)

Present value of 25 installment= $50,000/(1.0820)^0+$50000/(1.0820)^1....+50000/(1.0820)^24

Present value of 25 installment= $50000*11.3555=$5,67,775 ( approx)

Option 1 : lumpsum payment option would be selected as there is less payment as compared to installment payments option.

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