Question

Precision Machining Corporation has been growing steadily over the past decade. Demand for the company’s
products continues to rise, so management has decided to expand the production facility; $2 800 000 has been
set aside for this over the next four years.
Management has developed two different plans for expanding over the next four years: Plan A and Plan B. Plan
A would require equal amounts of $750 000, one year from now, two years from now, three years from now,
and four years from now. Plan B would require $300 000 now, $700 000 one year from now, $900 000 two
years from now, and $975 000 four years from now.
The company has decided to fund the expansion with only the $2 800 000 and any interest it can earn on it.
Before deciding which plan to use, the company asks its treasurer to predict the rates of interest it can earn on
the $2 800 000. The treasurer expects that Precision Machining Corporation can invest the $2 800 000 and earn
interest at a rate of 4.5% p.a. compounded semi-annually during Year 1, 5.0% p.a. compounded semi-annually
during Years 2 and 3, and 5.5% p.a. compounded semi-annually during Year 4. The company can withdraw part
of the money from this investment at any time without penalty.
Questions
1.
a. Could Precision Machining Corporation meet the cash requirement of Plan A by investing
the $2 800 000 as described above? (Use “now” as the focal date.)
b. What is the exact difference between the cash required and the cash available from the
investment?
2.
a. Could Precision Machining Corporation meet the cash requirements of Plan B by investing
the $2 800 000 as described above? (Use “now” as the focal date.)
b. What is the difference between the cash required and the cash available from the
investment?
3.
a. Suppose Plan A was changed so that it required equal amounts of $750 000 now, one year
from now, two years from now, and four years from now. Could Precision Machining
Corporation meet the cash requirements of the new Plan A by investing the $2 800 000 as
described above? (Use “now ” as the focal date.)
b. What is the difference between the cash required and the cash available from the
investment?
4. Suppose the treasurer found another way to invest the $2 800 000 that earned interest at a rate of 4.9%
compounded quarterly for the next five years.
a. Could the company meet the cash requirements of the original Plan A with this new
investment? (Show all your calculations.)
b. Could the company meet the cash requirements of Plan B with this new investment? (Show
all your calculations.)
c. If the company could meet the cash requirements of both plans, which plan would the
treasurer recommend? In other words, which plan would have the lower present value?

this is the case study

Answer 1

1.

a.

Computation of Cash Requirement of PLAN A

Years	Deposit opening balance	Interest Factor	Interest Earned	Total Cash Available	Requirement	Balance
1	$                  28,00,000.00	1.0455	$            1,27,417.50	$          29,27,417.50	$7,50,000.00	$ 21,77,417.50
2	$                  21,77,417.50	1.0506	$            1,10,231.76	$          22,87,649.26	$7,50,000.00	$ 15,37,649.26
3	$                  15,37,649.26	1.0506	$               77,843.49	$          16,15,492.75	$7,50,000.00	$   8,65,492.75
4	$                     8,65,492.75	1.0558	$               48,256.63	$            9,13,749.39	$7,50,000.00	$   1,63,749.39

Therefore from the above the company is able to meet the requirements of PLAN-A

b.

The exact difference of cash required and cash available from investment is $163,749.39

2.

a. Computation of Cash Requirement of PLAN B

Years	Deposit opening balance	Interest Factor	Interest Earned	Total Cash Available	Requirement	Balance
0	$                  28,00,000.00	0.0000		$          28,00,000.00	$3,00,000.00	$ 25,00,000.00
1	$                  25,00,000.00	1.0455	$            1,13,765.63	$          26,13,765.63	$7,00,000.00	$ 19,13,765.63
2	$                  19,13,765.63	1.0506	$               96,884.38	$          20,10,650.01	$9,00,000.00	$ 11,10,650.01
3	$                  11,10,650.01	1.0506	$               56,226.66	$          11,66,876.67	$                  -	$ 11,66,876.67
4	$                  11,66,876.67	1.0558	$               65,060.67	$          12,31,937.33	$9,75,000.00	$   2,56,937.33

Therefore from the above the company is able to meet the requirements of PLAN-A

b.

The excat difference cash required and cash available for investment is $256,937.33

3.

a.

Years	Deposit opening balance	Interest Factor	Interest Earned	Total Cash Available	Requirement	Balance
0	$                  28,00,000.00	0.0000		$          28,00,000.00	$7,50,000.00	$ 20,50,000.00
1	$                  20,50,000.00	1.0455	$               93,287.81	$          21,43,287.81	$7,50,000.00	$ 13,93,287.81
2	$                  13,93,287.81	1.0506	$               70,535.20	$          14,63,823.01	$7,50,000.00	$   7,13,823.01
3	$                     7,13,823.01	1.0506	$               36,137.29	$            7,49,960.30		$   7,49,960.30
4	$                     7,49,960.30	1.0558	$               41,814.97	$            7,91,775.27	$7,50,000.00	$      41,775.27

The company would be able to meet the requirements of Plan-A

b.

The excat difference cash required and cash available for investment is $41,775.27

4.

a. Plan -A

Years	Deposit opening balance	Interest Factor	Interest Earned	Total Cash Available	Requirement	Balance
1	$                  28,00,000.00	1.0499	$            1,39,741.70	$          29,39,741.70	$7,50,000.00	$ 21,89,741.70
2	$                  21,89,741.70	1.0499	$            1,09,285.08	$          22,99,026.78	$7,50,000.00	$ 15,49,026.78
3	$                  15,49,026.78	1.0499	$               77,308.44	$          16,26,335.23	$7,50,000.00	$   8,76,335.23
4	$                     8,76,335.23	1.0499	$               43,735.92	$            9,20,071.15	$7,50,000.00	$   1,70,071.15

b. PLAN B

Years	Deposit opening balance	Interest Factor	Interest Earned	Total Cash Available	Requirement	Balance
0	$                  28,00,000.00	0.0000		$          28,00,000.00	$3,00,000.00	$ 25,00,000.00
1	$                  25,00,000.00	1.0499	$            1,24,769.38	$          26,24,769.38	$7,00,000.00	$ 19,24,769.38
2	$                  19,24,769.38	1.0499	$               96,060.91	$          20,20,830.29	$9,00,000.00	$ 11,20,830.29
3	$                  11,20,830.29	1.0499	$               55,938.12	$          11,76,768.40	$                  -	$ 11,76,768.40
4	$                  11,76,768.40	1.0499	$               58,729.86	$          12,35,498.27	$9,75,000.00	$   2,60,498.27

c.

Company meet the cash requirements of both plans, the tresurer should select PLAN-B since it gives more cash balance at the end of five year i.e, $260,498.27 compared to Plan A which gives $170,071.15

PART B should be selected.