Question

Assume that Sonic Foundry Corporation has a contractual debt outstanding. Sonic has available two means of settlement. It can either make immediate payment of $2,366,000, or it can make annual payments of $342,200 for 15 years, each payment due on the last day of the year.

Which method of payment do you recommend, assuming an expected effective interest rate of 12% during the future period? (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

Answer 1

The recommended method of payment is immediate payment of $2,366,000 as it has a lower present value compared to the annual payments option.

To determine which method of payment is recommended, we need to calculate the present value of both options.

Option 1: Immediate payment of $2,366,000

The present value of this option can be calculated using the formula:

PV = Future Value / (1 + interest rate)^t

PV = 2,366,000 / (1 + 0.12)^0

PV = $2,366,000

Option 2: Annual payments of $342,200 for 15 years

The present value of this option can be calculated using the formula:

PV = Payment × [(1 - (1 + interest rate)^(-t)) / interest rate]

PV = 342,200 × [(1 - (1 + 0.12)^(-15)) / 0.12]

PV = $2,898,333.11

Based on the calculations, it is recommended to choose the immediate payment option as it has a lower present value of $2,366,000 compared to $2,898,333.11 for the annual payments option.