Ch. 10 - Inclass Exercise

1. Your organization needs $12,500 in order to replace tires on their fleet of transport trucks. How much

would they need to deposit today in a savings account that pays 2% interest, compounded annually, to

achieve $12,500 at the end of one (1) year? (Use the Present Value Table found on page 10.5)

PV = FV(1+r)

PV = 12500(1+.02) or = 12500x 0.9804

PV = $12,255

2.

Your company has just signed a contract with Highland Widgets to ship parts and supplies from across

Ontario into their Burlington plant. The contract will run for three years with a net payment upon

completion of $200,000. Part of the negotiations for the contract was how you will receive the payable.

Consider the following options;

a.

You have the option of receiving full payment on a shipping contract in the amount of $200,000 at the

end of the contract term in three (3) years, or accepting a reduced amount today. What is the minimum

amount you would accept today, assuming you could earn 5% interest on the money in a guaranteed fund

over the next three years? (Use the Present Value Table found on page 10.5)

PV = 200000 x 0.8638

PV = $172,760

b

.

Alternately, you have the option to receive your payable in quarterly payments of $15,000 over the

three (3) years. Assuming a return from your investment of that money of 4%, would this be a better

option? (Use the Present Value of an Annuity Table on page 10.6)

PVA = A x PVAF

PVA = 60000 x 2.7751

PVA = $166,506

c.

The third option is to receive $40,000 at the end of the first year, $75,000 at the end of the second year

and a further $75,000 at the end of the third year. Assuming a rate of return of 6%, how does this option

compare? (Use the Present Value of $1 to be Received After n Periods table on page 10.8)

Year Payment PV factor PV

1 40,000 0.9434 $37,736

2 75,000 0.8900 $66,750

3 75,000 0.8396 $62,970

Total: $167,456

d

.

In your opinion, and from a risk management perspective, what is the best option for your organization

and why