Value of a mixed stream Harte Systems, Inc., a maker of electronic survillance e
ID: 2383389 • Letter: V
Question
Value of a mixed stream Harte Systems, Inc., a maker of electronic survillance equipment, is considering selling to a well - known hardware chain the rights to market its home security system. The proposed deal calls for the hardware chain to pay Harte $32,000 and $25,000 at the end of years 1 and 2 and to make annual year - end payments of $16,000 in years 3 through 9. A final payment to Harte of $15,000 would be due at the end of year 10. a. Select the time line that represents the cash flows involved in the offer. b. If Harte applies a required rate of return of 12% to them, what is the present value of this series of payments? c. A second company has offered Harte an immediate one - time payment of $100,000 for the rights to market the home security system. Which offer should Harte accept?Explanation / Answer
ANSWER for a. is C i.e. the time line which represents the stream of future cash-flows is:
0 1 2 3 ...................................................9 10
I I I I .................. ................................I I
$32,000 $25,000 $16,000 ...........................................$16,000 $15,000
This is because all of these future cash-flows are incoming cash-flows for Harte Systems, Inc. and hence all of them are to be shown as positive amounts on the timeline.
ANSWER for b. is $111542.05
This is because we have to work out the Present Value of all 10 future expected cash-flows wherein the expected rate of return is 12% per annum
Thus, we will have to apply discounting of future cash-flows formula [which is opposite of compunding formula and is derived from the very same coumpounding formula, which we all know] to find the Present Value from Future Expected Values (denoted by FCF i.e. Future Cash Flow). It is given by following formula:
PV= Summation of (FCFi / (1+r/100)i) where i ranges from 1 to 10.. [i indicates number of the year]
Solving the above formula equation in MS Excel spreadsheet, we get the following answer:
Thus, PV= $111542.05
ANSWER for c. is that Harte Systems, Inc. should accept the first offer that it has received i.e. from well-known hardware chain because the PV of all its expected future cash-inflows works out to $1,11,542.05 [as calculated above], which is a higher amount than the second offer amount of $1,00,000 to be received at present as one-time immediate payment.
This is because the PV of all 10 future cash inflows is arrived at after adequately discounting them for their riskiness and uncertainties @ opportunity cost of capital i.e proper hurdle rate or expected rate of return which is derived using actual returns from other deals in the market with similar risk-profiles as that of this deal. Moreso, this is a Deal between two parties wherein the FCFs are pre-decided, freezed and agreed upon in advance, which is always documented on hard-copy papers duly signed by both the parties as a contract/agreemeent which is subject to the local region laws and jurusdiction; Unlike in a business project valuation [capital budgeting process] or an entire business valuation where FCFs are not known in advance [nor can they be freezed upon or pre-decided in advance] due to uncertainties of future business conditions and are calculated based on many assumptions about future busniess variables.
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