Question

NPV Simes Innovations Inc., is negotiating to purchase exclusive rights to manufacture and market a solar-powered toy car The car's inventor has offered Simes the choice of either a one-time payment of $1,900,000 today or a series of 7 year-end payments of $370,000

a. if Simes has a cost of capital of 0%, which form of payment should it choose?
b. What yearly payment would make the two offers identical in value at a cost of capital of 8%?
c. What would be your answer to part a of this problem if the yearly payments were made at the beginning of each year?
d. The cash inflows associated with this purchase are projected to amount to $240,500 par year for 15 years Will this factor change the firm's decision about how to fund the initial investment?

Answer 1

The decision on whether to take a one-time payment or a series of payments for purchasing exclusive rights depends on the cost of capital for Simes Innovations Inc. Additionally, the timing of payments and projected cash inflows from the investment also affect this financial judgment. Option D is correct answer.

Step-by-step explanation:

The NPV (Net Present Value) decision involves comparing the present value of a lump sum today against the present value of future cash inflows. If Simes Innovations Inc. has a cost of capital of 0%, the choice between a one-time payment of $1,900,000 and a series of 7 year-end payments of $370,000 is simply a matter of adding up the payments. No discounting is necessary, and the total of the 7 payments ($2,590,000) is greater than the one-time payment of $1,900,000, hence the series of payments is the better option.

However, when the cost of capital is 8%, the future payments must be discounted to present value. To find the annual payment (Yearly Payment) that would equate to the $1,900,000 received today, we use the formula of an annuity discounted at the cost of capital rate. If the payments were made at the beginning of each year (Beginning of Year payments), their present value would be slightly higher because they would be discounted over a shorter period.

The decision may change if the cash inflows from the investment are considered, such as the projected $240,500 per year for 15 years from the solar-powered toy car. This would factor into the overall NPV calculation and could influence whether front-loading the investment or spreading it out over time is more beneficial.