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# Time Value of Money Questions

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P6-7 (Time Value Concepts Applied to Solve Business Problems) Answer the following questions
related to Derek Lee Inc.

(a) Derek Lee Inc. has \$572,000 to invest. The company is trying to decide between two alternative uses of the funds. One alternative provides \$80,000 at the end of each year for 12 years, and the other is to receive a single lump sum payment of \$1,900,000 at the end of the 12 years. Which alternative should Lee select? Assume the interest rate is constant over the entire investment.

(b) Derek Lee Inc. has completed the purchase of new Dell computers. The fair market value of the equipment is \$824,150. The purchase agreement specifies an immediate down payment of \$200,000 and semiannual payments of \$76,952 beginning at the end of 6 months for 5 years. What is the interest rate, to the nearest percent, used in discounting this purchase transaction?

(c) Derek Lee Inc. loans money to John Kruk Corporation in the amount of \$600,000. Lee accepts an 8% note due in 7 years with interest payable semiannually. After 2 years (and receipt of interest for 2 years), Lee needs money and therefore sells the note to Chicago National Bank, which demands interest on the note of 10% compounded semiannually. What is the amount Lee will receive on the sale of the note?

(d) Derek Lee Inc. wishes to accumulate \$1,300,000 by December 31, 2017, to retire bonds outstanding. The company deposits \$300,000 on December 31, 2007, which will earn interest at 10% compounded quarterly, to help in the retirement of this debt. In addition, the company wants to know how much should be deposited at the end of each quarter for 10 years to ensure that \$1,300,000 is available at the end of 2017. (The quarterly deposits will also earn at a rate of 10%, compounded
quarterly.) (Round to even dollars.)

See attached file...

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#### Solution Preview

The answers are in attached file
"(a) Derek Lee Inc. has \$572,000 to invest. The company is trying to decide between two alternative uses of the funds. One alternative provides \$80,000 at the end of each year for 12 years, and the other is to receive a single lump sum payment of \$1,900,000 at the end of the 12 years. Which alternative should Lee select? Assume the interest rate is constant over the entire investment.
"

We have to compare the rate of return on the two alternatives.
Amount to be invested= \$572,000

Alternative 1:
present value of annual payments= \$572,000

annual payments= \$80,000
Number of years= 12
Therefore number of periods= 12

PVIFA (r%, 12) x \$80,000 = \$572,000
or PVIFA (r%,12) = 7.1500 =\$572,000./\$80,000.

Looking up the tables a PVIFA value refers to r= 9%

Therefore, rate of return for alternative 1= 9%

Alternative 2:
present value of future lump sum payment= \$572,000

future payment= \$1,900,000
Number of years= 12
Therefore number of periods= 12

PVIF (r%, 12) x \$1,900,000 = \$572,000
or PVIF (r%,12) = 0.30105 =\$572,000./\$1,900,000.

Looking up the tables and interpolating the PVIF value refers to r= 10.50%

Therefore, rate of return for alternative 2= 10.50%

Answer: Since alternative 2 has a higher rate of return, alternative 2 is better.

"(b) Derek Lee ...

#### Solution Summary

Time Value of Money Questions have been answered.

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