Question

Using Present Value Concepts for Decision Making

Answer 1

Answer:

1. Option 1: Present value of cash winnings collected today = $105,000 * 1 = $105,000

Option 2: Present value of annual cash collections = $20,700 * 5.033 =       $104,183

2. Option 1 should be selected.

Explanation:

a) Data and Calculations:

Cash winnings collected today = $105,000

Annual cash collection = $20,700

Discount factor = 9%

Period of annual cash flows = 7 years

Present Value Annuity Factor at 9% for 7 years = 5.033

Present value of cash winnings collected today = $105,000 * 1 = $105,000

Present value of annual cash collections = $20,700 * 5.033 =       $104,183

NPV = ($817)

b) Option 1 is worth more in present value terms than option 2.  The present value consideration is all about taking into account the time value of money.  Using a present value annuity factor of 5.033, the annual cash inflows are determined to their present value to be $104,183.  This is less than the $105,000 cash collected today in bulk.