+598 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.
Before the final decision on implementation, the company treasurer is asked to assess the plan to determine if the current $2.6 million allocation will meet the $2.8 million in payment obligations of the plan over the four-year period. The Treasurer has predicted interest rates over the next four years to be as follows:
Year 1: interest rate of 4.5% p.a. compounded semi-annually
Year 2: interest rate of 5.0% p.a. compounded semi-annually
Year 3: interest rate of 5.0% p.a. compounded semi-annually
Year 4: interest rate of 5.5% p.a. compounded semi-annually
Similar to previous question but with alteration below :
Since the Treasurer’s investment plan has a guaranteed rate for five years, suppose the company decided to delay the expansion for twelve months to take advantage of this fact. The payment plan to fund the expansion would retain the same payment schedule. However, the final payment in the last year would increase by 10%, due to projected increase in construction costs.
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6. What is the equivalent value, twelve months from now, of the cash available to fund the expansion? Show your calculations.
7. Twelve months from now, what is the total of the value of the required cash payments? Show your calculations.
8. Twelve months from now, what is the difference between the value of the funds available from (6), and the total present value of the required payments determined in (7)? Show your calculations.
9. What is the accumulated value of this difference at the end of the expansion period? Show your calculations
ANSWERS:
6. =$2,737,859.32- This is the FV of $2,600,000 one year from now. Use this formula to get this:
FV=PV[1 + R]^N=FV OF $1 TODAY.
7.Since the PV of all the cash payments inculding the 10% increase in the last payment is=$2,579,689.61. Twelve months from now, it will be worth=$2,697,081.61. Use the exact same formula above.
8. $2,737,859.32 - $2,697,081.61=$40,777.71
9. The accumulated value of this difference will be=$52,797.30. Use the exact same formula above.
Opinion Question : 10. In your opinion, should the proposed expansion be delayed or not? Explain your choice, giving advantages and risks.
Looking for a second opinion on the risk and advantages of executing the expansion immediatly or waiting the 12 months. Thanks any input would be appreciated.
You are asking a person who was an investment Banker, NOT an executive of a company running a real business. But, based solely on these calculations, it wouldn't make much material difference to the company, since the net gain is relatively minor, about $53,000 over 5 years. On the hand, delaying the expansion for one year might bring some unexpected surprises, such as rising costs of the project, rising interest rates and other unforseen economic conditions.....etc. So, all in all, I would go ahead with the expansion NOW!, and not delay it for a year. That's my personal opinion and NOT based on any financial calculations, for they are relatively minor for the company. Hope this will satisfy your prof.!
You are asking a person who was an investment Banker, NOT an executive of a company running a real business. But, based solely on these calculations, it wouldn't make much material difference to the company, since the net gain is relatively minor, about $53,000 over 5 years. On the hand, delaying the expansion for one year might bring some unexpected surprises, such as rising costs of the project, rising interest rates and other unforseen economic conditions.....etc. So, all in all, I would go ahead with the expansion NOW!, and not delay it for a year. That's my personal opinion and NOT based on any financial calculations, for they are relatively minor for the company. Hope this will satisfy your prof.!
+598 Hey all the help has been much appreciated, I can not thank you enough.
All the best to you and your family over the holidays.
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