Simes Innovations, Inc., is negotiating to purchase exclusive rights to manufact

Question

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 $1,800,000 today or a series of five year-end payments of $360,000.

a. If Simes has a cost of capital of 8%, 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 8%?

c. What would be your answer to part a of this problem if the yearly paymenys were made at the beginning of each year?

d. The after-tax cash inflows associated with this purchase are projected to amount to $234,000 per year for 16 years. Will this factor change the firm's decision about how to fund the initial investment.

Please show work** I dont understand how you do it on the calculator

Explanation / Answer

Part A)

We first need to compute the PV of annuity payment:

Calculator inputs:

I/Y = 8%

N = 5

Pmt = 360,000

Solve for PV

PV= 1437375.61

Simes should choose to make annual payment of 360,000 as it has lower present value than one time payment.

Part B)

We have:

I/Y =8%

N=5

PV= 1,800,000

Solve for pmt

Pmt = 450821.62

So an annual payment of 450,821.62 would make the two offers identical.

Part C)

Now set the calculator to begin mode and use the following inputs

I/Y = 8%

N = 5

Pmt = 360,000

Solve for PV

PV= 1,552,365.66

Again annual payment is a better option as it has lower PV than one time payment.

Part d)

We need to compute the pv of this payment:

I/Y = 8%

N = 16

Pmt = 234,000

Solve for PV

PV= 2,071,220.38

Yes, now the Value of payments is higher than one-time payment alternative. Therefore, one time payment alternative is better.

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