A generous university benefactor has agreed to donate a large amount of money fo

Question

A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump-sum of $10mln, or in parts, where $5.5mln can be provided in year 1, and another $5.5mln can be provided in year 2. Assuming the opportunity interest rate is 6%, what is the present value of the second alternative? Which of the two alternatives should be chosen and why? How would your decision change if the opportunity interest rate was 12%? Please, show all your calculations.

Explanation / Answer

1) NPV= $ 5.5 mln( 1+0.06)+ $ 5.5 mln (1+0.06)^2 = $ 10.08 mln

2 nd alternative is better since Net present value of it is more the $ 10 mln ( 10.08 >10 ) mln $

since value of money depreciate over time but in this case NPV in 2nd alternative is more hence preferred

2) when when r =0.12

    NPV= $ 5.5 mln( 1+0.12)+ $ 5.5 mln (1+0.12)^2 = $ 9.29 mln

in this case NPV is less than $ 10 mln hence $ 10 mln lump sump is profitable

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