Comparing Options Using Present Value Concepts
After hearing a knock at your front door, you are surprised to see the Prize Patrol from a large, well-known magazine subscription company. It has arrived with the good news that you are the big winner, having won “$20 million.” You discover that you have three options: (1) you can receive $1 million per year for the next 20 years, (2) you can have $8 million today, or (3) you can have $2 million today and receive $700,000 for each of the next 20 years. Your financial adviser tells you that it is reasonable to expect to earn 10 percent on investments. Which option do you prefer? What factors influence your decision?
TIP: All three scenarios require you to determine today’s value of the various payment options. These are present value problems.
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- Better Friend Company chief executive officer (CEO )is looking into two options to invest so that in three years from now his company we be able to buy an equipment that has been estimated to cost $100,000.00 three years from now. Option 1 is for him to invest with a bank that pays an interest rate of 8% by investing $30,000.00 now, $20,000.00 in 2 years from now and add the rest of the money needed in year 3 to buy the equipment. Option 2 is for him to invest now all the money he needs to buy the equipment in three years from now. Which investment option is better for the CEO? Draw the cash flow diagrams for both options.arrow_forwardGive typing answer with explanation and conclusion You have decided to renovate your suites in order to capture more revenue. If it costs $1,000,000 to renovate and you expect to achieve $200,000 in incremental profit per year, what is the net present value of this project over 10 years at a discount rate of 8%?arrow_forwardCongratulations. You have just won first prize in a quantitative competition. You have the following choices to receive your winnings: Option I: Receive $3,000,000 immediately. Option II: Receive five $1,000,000 payments paid every other year beginning in year T=2. For example, you receive a $1 million dollars payment in year T=2, T=4, T=6, T=8, and T=10. a. What is the present value of each option if R=0.06? Which option would you choose? b. What is the present value of each option if R=0.12? Which option would you choose? c. What interest rate R will make the present value of both options equal? Hint: use Excel’s Data – What If - Goal Seek analysis Show what you do to se up goal seek for carrow_forward
- Congratulations. You have just won first prize in a quantitative competition. You have the following choices to receive your winnings: Option I: Receive $3,000,000 immediately. Option II: Receive five $1,000,000 payments paid every other year beginning in year T=2. For example, you receive a $1 million dollars payment in year T=2, T=4, T=6, T=8, and T=10. a. What is the present value of each option if R=0.06? Which option would you choose? b. What is the present value of each option if R=0.12? Which option would you choose? c. What interest rate R will make the present value of both options equal? Hint: use Excel's Data - What If - Goal Seek analysis Show what you do to se up goal seek for c Also take snap shots from excel and how did you get the answers, please show work for c!!!arrow_forwardUse Excel to calculate the solutions to the following problems. Your worksheet will be graded on accuracy, dynamic calculations, and presentation of solutions (should be well organized with variables clearly labeled). 1. What is the future value in 30 years of $5,000 invested today at 8.0%? 2. What is the present value of $1,000,000 received 6 years from today if the appropriate discount rate is 4.0%? 3. What is the present value of ordinary annuity of $400 per year for 8 years if the discount rate is 10.0%? 4. What is the future value of an annuity due of $500 deposited per month into account paying 12.0% annually for 25 years?arrow_forwardYou would like to have $300,000 saving to retire in 25 years and considering an investment strategy with two phases: Phase 1: Contributing an identical amount of money into an investment plan at the end of each year, given the rate of return of 12% to get a total saving of $200,000 after 15 years. Phase 2: Investing that $200,000 accumulate in the first 15 years as a lump sum in an investment in the securities market for the left 10 years. Your financial adviser recommends two alternative options: Option A pays interest rate of 12.88%, compounding weekly. Option B pays interest rate of 13%, compounding annually. Required: Calculate the identical amount of money you should contribute at the end of each year in Phase 1. In phase 1, if you contribute the same amount, but at the beginning of each year, how much would you get from this investment after 15 years Identify which option should you choose in Phase 2 by computing the effective annual interest rate (EAR) Calculate the…arrow_forward
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- An example of how to calculate net present value is done using the following. Imagine you have been given an investment opportunity wherein if you invest $1,200 today, you will receive $650 dollars at the end of each year for the next 5 years. You could separately choose to invest your money at 10% interest each year. Should you take the investment opportunity? To find the answer, use the NPV formula:arrow_forwardRISK & RETURN AND PAYOFF TABLES TUTORIAL QUESTION 1 Mr. Nel, an entrepreneur who is currently 55 years old, took early retirement from his business which he had started 30 years ago. He still wants to be involved in investments to keep his mind occupied while on “permanent” holiday. While thinking about investment opportunities, he realised that one of his most consistent expenses is his cell phone bill. He has a MTN and a separate VODACOM contract which he pays monthly. He thought to himself, “Why not invest in the company that I am contributing to on a monthly basis.” He decided to conduct research on the two entities in order to assist him with his investment decision. The following information was gathered regarding the two companies: VODACOM Vodacom is a leading African communications group providing mobile communications and related services to 40.4 million customers. Its mobile network covers calls to a total population of approximately 182 million people across five…arrow_forwardExecutives at Microsoft are interested to get into the drone delivery business.They decide to acquire "FLY" corporation."FLY" has been operating a drone delivery service for 4 years now and they are the most successful operators in the market. Microsoft executives offer "FLY" 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. a)If the annual interest rate is 7% ,find the present value of both options? b) Evaluate the net present values of both option and identify which option is more cost effective for Microsoft ?arrow_forward
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