Kowalski Corporation’s management took the following actions, which went into effect on January 2, 2011. Each action involved an application of present value.

a. Entered into a purchase agreement that calls for a payment of $650,000 six years from now.

b. Bought out the contract of a member of top management for a payment of $70,000 per year for five years beginning January 2, 2012.

REQUIRED

1. Assuming an annual interest rate of 10 percent and using Tables 1 and 2 from Appendix B, answer the following questions:

a. In action a, what is the present value of the liability for the purchase agreement?

b. In action b, what is the cost (present value) of the buyout?

2. Many businesses analyze present value extensively when making decisions about investing in long-term assets. Why is this type of analysis particularly appropriate for such decisions?