The expansion will occur over 4 years and is expected to require $2.8 million.
Management has developed a payment plan for carrying out this expansion. The plan requires a cash input of $300,000 now, $700, 000 one year from now, $800,000 two years from now, and finally, $1,000,000 four years from now.
the Treasurer has found that the $2.6 million cash allocation could be invested at a fixed rate of 5.2% p.a. compounded quarterly for a period of five years.
1. Can Focus Drilling meet the cash payment requirement by investing with the fixed five-year interest rate given above? Show your calculations.
2. What, if any, is the accumulated value of the difference between the allocated cash available and the total cash payments required for the expansion?
Any help would be greatly appreciated with steps - thanks
Of the reserve fund of $2,600,000, the first payment of $300,000 is due now and must be subtracted from the reserve fund, which would leave you with $2,300,000. This amount will be invested for 5 years at the rate of 5.2% comp. quarterly. It is assumed that this investment in not "locked in" and that the company can withdraw the needed payments as they come due.
If this assumption is right, then the $2,300,000 will be worth $2,421,952.48 in one year from now. From this you have to subtract the $700,000 due. That leaves you $1,721,952.48. This amount will continue to earn to earn interest for another year, at which time it will be worth $1,813,255.25. From this amount you will have to subtract $800,000 due in 2 years, which will leave you with $1,013,255.25. This amount will continue to earn interest for another 2 years, which comes to $1,123,555.23. Now, from this amount you have to subtract $1,000,000 due in the 4th year, which will leave you with $123,555.25. This amount will continue to earn interest for another year, which comes to $130,106.47 at the end of the 5th year.
From these calculations, you can easily answer their questions.