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Question 2Executives at Microsoft are interested to get into the drone delivery business. Since it would take them too much time to set up their own operation, they decide to acquire “Flyit” corporation. “Flyit” has been operating a drone delivery service for 4 years now, and they are the most successful operators in the market. Microsoft executives offer “Flyit” two purchase options. The first option is one $40 million lump sum payment. The second option is paying five annual payments of $10 million over the next five years.If the annual interest rate is 7%, find the present value of both options? [Note: you are supposed to show every step of your calculation and interpret the result] (Evaluate the net present values of both option and identify which option is more cost effective for Microsoft?

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Question 2

Executives at Microsoft are interested to get into the drone delivery business. Since it would take them too much time to set up their own operation, they decide to acquire “Flyit” corporation. “Flyit” has been operating a drone delivery service for 4 years now, and they are the most successful operators in the market. Microsoft executives offer “Flyit” two purchase options. The first option is one $40 million lump sum payment. The second option is paying five annual payments of $10 million over the next five years.

  1. If the annual interest rate is 7%, find the present value of both options? [Note: you are supposed to show every step of your calculation and interpret the result] (
  2. Evaluate the net present values of both option and identify which option is more cost effective for Microsoft?

 

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Step 1

We need to use the concept of time value of money to solve the question. According to the concept of time value of money, the value of money available at the present time is more compared to the same sum of amount in some future time. This is because of the earning potential of money, that is, we can earn interest on money by investing it.

Step 2

Part 1:
In the first option a lump sum amount of $40 million will be paid in year 0.
In the second option an amount of $10 million will be paid annually over a period of 5 years.
So, we need to calculate the present value of the annual payments.

Step 3

CF1 to CF5 refers to the cash flows from year 1 to year 5, and r is the interest rate.  Given that the cash flows...

The formula for time value of money is:
Future value-(Present value)x(1+ Interest rate)Number of years
=>Present value=(Future value)+(1 + Interest rate)Number of years
Here, the present value of the future cash flows is calculated as:
CF1 (1rCF2-(1+r)2 CF3-(1+r)3 CF4 (1+r) 4 +CF5 (1+r)
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The formula for time value of money is: Future value-(Present value)x(1+ Interest rate)Number of years =>Present value=(Future value)+(1 + Interest rate)Number of years Here, the present value of the future cash flows is calculated as: CF1 (1rCF2-(1+r)2 CF3-(1+r)3 CF4 (1+r) 4 +CF5 (1+r)

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