Question

1. A trading firm is deciding between subscribing to three different data services. Each service will generate revenues of $500,000 per month for four years with the first payment received in one month. The three services available are as follows:

   1. (i) pay $600,000 today plus a monthly fee. The fee is $80,000 in one month then decrases by five percent per month for eleven months. Then it remains the same for the next three years.

   2. (ii) Pay two million today.

   3. (iii) Pay $120,000 fee in the first year then in each subsequent year, the fee decreases by $20,000 until the project is finished.

   The effective risk-free annual interest rate is 8 percent.
   (a) What is the effective monthly discount rate for this project. What is the annual percentage rate (APR)?

   (b) Use NPV to value which of these services is best for the project.

Answer 1

The best services is (iii) as it provides highest NPV