S A Tool Maker Shop must borrow $20,000 to purchase an equipment the local bank
ID: 2600146 • Letter: S
Question
S A Tool Maker Shop must borrow $20,000 to purchase an equipment the local bank has offered the following choice of payment Plans, each determined by using an interest rate of 12%. If the Shop's minimum attractive rate of return (MAR) is 15%. which plan should he choose? Expiain in desal your setap Formula, Calculation, and recommendation. Plan A: $ 5010 per year for 5 years Plan B: $2956 per year for 4 years plus $15,000 at end of 5 years Plan C: Nothing for 2 years, then $9048 per year for 3 yearsExplanation / Answer
Plan which has lower present value will be selected. Each paln is valued at rate of 15% Present Value of Plan A: Present Value = Annual Value x Cumulative discount fator = $ 5,010 x 3.3522 = $ 16,794 Working: Cumulative discount factor = (1-(1+i)^-n)/i Where, = (1-(1+0.15)^-5)/0.15 i = 0.15 = 3.3522 n = 5 Present Value of Plan B: Year Cash flow Discount factor Present Value 1 $ 2,956 0.8696 $ 2,570 2 $ 2,956 0.7561 $ 2,235 3 $ 2,956 0.6575 $ 1,944 4 $ 2,956 0.5718 $ 1,690 5 $ 15,000 0.4972 $ 7,458 Present value $ 15,897 Present Value of Plan C: Year Cash flow Discount factor Present Value 1 0 0.8696 0 2 0 0.7561 0 3 $ 9,048 0.6575 $ 5,949 4 $ 9,048 0.5718 $ 5,173 5 $ 9,048 0.4972 $ 4,498 Present value $ 15,621 Now, Net Present Value Plan A $ 16,794 Plan B $ 15,897 Plan C $ 15,621 Decision: Plan C has lower present value .So, Plan C is beneficial and he should choose Plan C
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