Question

48. BellTech, a major technology corporation, is considering purchasing AltPro, an alternative product company. During negotiations, the proprietor of AltPro says he wil sell his company and patent for either $1,500,000 now or a payment of $400,000 a year over the next five yoars (A) If BerTech can make investments elsewhere at an 8% rate of return, which option would you advise? Explain your rationale. (B) Describe how changes in rates of return would affect your recommendation. (C) What other factors should BellTech take into account before making its decision?

Answer 1

(A)In Order to compare both the options, present value of payments under both the options should be compared.

Option 1: Pay now $1,500,000

Option 2: Pay $400,000 per year

Present Value at 8% return = 400,000*PVAF(8%, 5 years)

= $400,000*3.993

= $1,597,200

Since present value of payment is lower in case of option 1, it is recommended that the payment should be made now.

(B)Changes in rate of return would affect the recommendation. If BellTech can earn more return by investing, then it is better to defer the payment and choose option2. In case it earns lesser return by investing, it is better to pay today.

(C) Other factors that should be taken into account are:

1. Volatility of rate of return

2. Investment Opportunities

3. Availability of funds