In: Finance
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.
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.