Question

You are the controller for Ivanhoe’s Pizzeria Inc. (IPI). Ivanhoe is contemplating the purchase of a new commercial pizza oven in his popular Southern Ontario pizzeria and is asking for your assistance in making his decision. From the options presented by his creditor, he has narrowed down his options as follows:

Option 1: Purchase the pizza oven with payments of $10,500 made semi-annually for 3 years. The interest rate on this arrangement is 8%.

Option 2: Purchase the pizza oven with annual payments for 3 years of $22,000 at 9% interest.

For each of the two options, using tables, a financial calculator or Excel function determine from a quantitative perspective, which of the two options should be pursued by Ivanhoe?

Answer 1

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Ivanhoe’s Pizzeria Inc. (IPI)
First we have to calculate the present value of payments. Then that option has to be selected where present value of total payment is less.
Particulars	Option 1	Option 2
Payment amount	10,500.00	22,000.00
Payment term	Semi annual	Annual
Number of Years	3.00	3.00
Number of Payments	6.00	3.00
Interest rate	8%	8%
Interest rate for present value purpose	0.04	0.08
Annuity factor	5.24214	2.57710
Present value of payments	55,042.44	56,696.13
Extra payment		1,653.70
We can see that present value of total payment is less in option 1. So option 1 should be selected.