Question

In: Finance

Simes​ Innovations, Inc., is negotiating to purchase exclusive rights to manufacture and market a​ solar-powered toy...

Simes​ Innovations, Inc., is negotiating to purchase exclusive rights to manufacture and market a​ solar-powered toy car. The​ car's inventor has offered Simes the choice of either a​ one-time payment of ​$1500000 today or a series of 6 ​year-end payments of ​$355000. a.  If Simes has a cost of capital of 9​%, which form of payment should it​ choose? b.  What yearly payment would make the two offers identical in value at a cost of capital of 9​%? c.  What would be your answer to part a of this problem if the yearly payments were made at the beginning of each​ year?   d.  The​ after-tax cash inflows associated with this purchase are projected to amount to ​$230750 per year for 15 years. Will this factor change the​ firm's decision about how to fund the initital​ investment?

a. If Simes has a cost of capital of

99​%,

the present value of the annuity is

​$nothing.

​(Round to the nearest​ dollar.)

Which form of payment should the firm​ choose?  ​(Select the best answer​ below.)

A.

Lump sum paymentLump sum payment

B.

Annuity paymentAnnuity payment

b.  The yearly payment that would make the two offers identical in value at a cost of capital of

99​%

is

​$nothing.

  ​(Round to the nearest​ dollar.)

c.  If the yearly payments were made at the beginning of each​ year, the present value of the annuity is

​$nothing.

  ​(Round to the nearest​ dollar.)

Which form of payment should the firm choose if the annuity payments are paid at the beginning of each​ year?  ​(Select the best answer​ below.)

A.

Lump sum paymentLump sum payment

B.

Annuity paymentAnnuity payment

d.  The​ after-tax cash inflows associated with this purchase are projected to amount to

​$230 comma 750230,750

per year for 15 years. Will this factor change the​ firm's decision about how to fund the initital​ investment?  ​(Select the best answer​ below.)

A.

​Yes, the cash flows from the project will influence the decision on how to fund the project. The investment and financing decisions are related.

B.

​No, the cash flows from the project will not influence the decision on how to fund the project. The investment and financing decisions are separate.

Solutions

Expert Solution

One-time payment of $1,500,000

Yearly payment (P) = $355,000

Cost of capital (r) = 9%

Number of payments (n) = 6

Present value of annuity payments = P[1-(1+r)^-n]/r

= 355,000[1-(1+9%)^-6]/9% = 1,592,501

a). Thus, if Simes makes annual payments for 6 years, it will end up paying (1,592,501 - 1,500,000) $92,501 more. It is better to make a one-time lump sum payment.

b). Let the yearly payment be P. Then, present value (PV) of these payments has to be equal to the one-time lump sum payment of $1,500,000

Then, P = PV*r/[1-(1+r)^-n]

= (1,500,000*9%)/[1-(1+9%)^-6]

= 334,379.67 or $334,380

c). PV of annuity due (payments made at the beginning of the year) = P + P[1-(1+r)^-(n-1)]/r

where P = 355,000, r = 9% and n = 6

PV = 355,000 + 355,000[1 - (1+9%)^-(6-1)]/9%

= 355,000 + 1,380,826.20

= 1,735,826

This PV is also higher than the one-time lump sum payment of $1,500,000 so Simes should make a lump sum payment only.

d). ​No, the cash flows from the project will not influence the decision on how to fund the project. The investment and financing decisions are separate.


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