Question

As CFO of a small manufacturing firm, you have been asked to determine the best financing for the purchase of a new piece of equipment. The vendor is offering repayment options of $10,000 at the end of each year for five years, or no payment for two years followed by one payment of $45,000. The current market rate of interest is 10%. Calculate present value of both options.(For calculation purposes, use 5 decimal places as displayed in the factor table provided. Round final answers to 2 decimal places, e.g. 5,275.25.)

	Present Value
Option 1		enter a dollar amount rounded to 2 decimal places
Option 2		enter a dollar amount rounded to 2 decimal places

Which option would you recommend? Option 1 or 2?

Answer 1

- Option 1: Repayment of $10,000 at the end of each year for 5 years.

Calculating the Present Value of Option 1:-

Where, C= Periodic Payments = $10,000

r = Periodic Interest rate = 10%

n= no of periods = 5

Present Value = $37,907.87

So, Present Value of option 1 is $37,907.87

- Option 2: No payment for 2 years followed by one payment of $45,000 in 3rd year

Calculating its Present Value:-

Present Value=Future Value/(1+r)^n

Where,Future Value = $45,000

r = Periodic Interest rate = 10%

n= no of periods = 3

Present Value = $45,000/(1+0.10)^3

= $45,000/1.331

= $33,809.17

So, Present Value of option 2 is $33,809.17

Since, the Present value of option 2 is less than Option 1. thus, Option 2 should be choosen.