Question

A E = = = : & Normal Normal No Spacing Heating 1. The executer of your late grandfather's estate has made the following offers to you: > RM 50 million now > RM 10 million a year for 8 years starting one year from now > RM 120 million at the end of year 8 a. Select the option you will take if the interest rate is 10%? b. Identify whether your choice will change if the interest rate is 12%. Discuss the concept of shareholder wealth maximization, muide a reasoned argument explain

Answer 1

1.

b) RM 50 million now.

Solution -

To select the most beneficial option, it is important to find the present value of each option.

Present value of first option = Rm 50 million (as the 50 million is given right now, there is no interest involved in this. So present value is 50 million).

Present value of second option = Rm 10 million × annuity factor at 10% for 8 years.

Where,

Annuity factor at 12% for 8 years = [1- (1+r)^-n ]/r

r = rate of interest = 0.12

n = number of years = 8

Annuity factor at 12% for 8 years = [1-(1+.012)^-8 ]/0.12

= [1- {1/(1.12)⁸ }]/0.12

= [1- {1/2.476}]/0.12

= [1- 0.4039]/0.12

= [0.5961]/0.12

=4.9675

Therefore,

Present value of second option = Rm 10 million ×4.9675

= Rm 49,675,000

Present value of third option = $120 million × present value factor for year 8 at 12%.

Where,

Present value factor = 1/(1+r)ⁿ

r = interest rate = 0.12

n = number of years = 8

Present value factor = 1/(1+0.12)⁸

= 1/(1.12)⁸

= 1/2.476

= 0.4039

Therefore,

Present value of third option = Rm 120 million × 0.4039

= Rm 48,468,000

As first option has more present value it is is selected.

a) Rm 120 million at the end of year 8.

Solution :

The same calculations are performed by taking interest as 10% .

Present value of first option = Rm 50 million.

Present value of second option = Rm 10 million × annuity factor at 10% for 8 years.

Annuity factor at 10% for 8 years = [1- (1+0.1)^-8 ]/0.1

= [1-(1.1)^-8 ]/0.1

= [1-1/(1.1)⁸ ]/0.1

= [1-1/(2.1436)]/0.1

= [1- 0.4665]/0.1

= [0.5335]/0.1

= 5.335

Present value of second option = Rm 10 million × 5.335 = Rm 53,350,000

Present value of third option = Rm 120 million × present value factor at 10% for year 8

Present value factor at 10% for year 8 = 1/(1+0.1)⁸ = 1/(1.1)⁸ = 1/(2.1436) = 0.4665

Present value of third option = Rm 120 million × 0.4665 = Rm 55,980,000

As third option has more present value it is selected