QUESTION 22

A company has purchased goods on invoice from a supplier. The following alternatives are offered for payment:

1) An upfront payment of $20,000 today

2) A lump sum payment of $25,000 due in three years' time

3) A payment plan of $700 per month paid at the end of each month for three years

4) A payment plan of $140 per month paid at the end of the month forever

Assume the interest rate is 8% per annum and that interest is compounded monthly for all alternatives.

(a) Explain why the time value of money needs to be considered before a decision can be made. (2 marks)

(b) Calculate the present value of each alternative and determine which payment option the company should accept. (8 marks)