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As an way to pay for various software that your company sells, a high-tech servi

ID: 2784623 • Letter: A

Question

As an way to pay for various software that your company sells, a high-tech service company has your company in any one of three ways: (1 pay $508,000 now. (2) pay $1.48 million 5 years from now or (3) 2 years from now You want to earn a rea!return of 12% per year and the inflation rate is t pay $200000 now and $419,000 4% per year in the specialized software market Use PW analysis to determine which offer you should accept with inflation considered Select offer with the highest PW value of $ Prex Prex 4 5flNext> 1211.2017

Explanation / Answer

Nominal Rate - Real Rate of return + Inflation rate

= 12% + 4%

Nominal Rate of return is 16%.

To solve this question calculate present value of each option at 16% interest rate.

In first option, $508,000 is pays now, so Present value of option 1 is $508,000.

In option 2

Present value = $1,480,000 / (1 + 16%) ^ 5

= $1,480,000 / 2.1003

= $704,647.26

Present value of second option is $704,647.26.

Option 3

Present value = $200,000 + [$419,000 / (1 + 16%) ^ 2]

= $200,000 + ($419,000 / 1.3456)

= $200,000 + $311,385.26

= $511,385.26.

Present value of third option is $511,385.26..

Since, Present value of second option is highest among all three option. So you should choose second option and present value of second option is $704,647.26.