Question

Mike is selling his vacation cabin on the lake. His asking price is $150,000 cash, but so far no one has offered to meet his terms. He expressed a willingness to finance the purchase himself and suddenly there were five offers on the table from Andy, Bill, Charlie, Dan, and Earl.

• Andy offered to pay him $60,000 today and to then make quarterly payments of $10,000 each quarter over the next three years.
• Bill has offered $90,000 today plus another $75,000 one year from now.
• Charlie has offered $15,000 today plus monthly payments of $1,800 over the next five years plus a one-time payment of $100,000 at the end of the fifth year period.
• Dan has offered $12,000 today and then $25,000 per year for 7 years plus a final one-time payment of $50,000 at the end of the seventh years.
• Earl has offered weekly payments of $500 per week for the next 10 years

Mike has asked you for some advice, based on your financial training from The Citadel. Mike has said that he considers 10% a fair rate of return on investments like this so that's the annual interest rate he would use to discount the cash flows, but doesn't have much of a clue beyond that how he should measure the value of the offers. You, of course, know that finance people compare the present value of all cash flows so as to find out which one is worth the most in today's dollars. Based on financial principles AND NOT on your own pre-conceptions or preferences, what is the best course of action for Mike: sell to Andy, sell to Bill, sell to Charlie, sell to Dan, sell to Earl, or hold onto the cabin. Show your work and/or justify your answer, and your answer needs to be based on financial principles.

Please remember that you are giving advice to someone else, based on that someone else's stated interest rate needs and financial principles. Too often, I get responses that start with "I would choose..." which means you are using your preferences. Instead of using your preferences, use Mike's preferences and financial principles. For example, in many instances students start out with "I would need a higher interest rate..." but it is not your cabin, it is Mike's cabin, and it is not your money, it is Mike's money, and it is not your interest rate preference, it is Mike's interest rate preference. So work with what you have been given.

*JUSTIFY YOUR ANSWER on a spreadsheet showing your TVM calculations.

Answer 1

Present value refers to the discounted value of the cash flows that will be received in future. The main premise of present value is the "Time Value of money" .it means that sum of rupee received today has more value than the same amount to be received in future.

In this case, Mike wants to sell his cabin for $150,000 today. The buyers are offering different payment methods to buy the cabin at future dates. Hence it is essential for Mike to find out the present value of the amount he'll be receiving in future.

Clipboard Font Alignment Number Styles Cells Editing G28 A B C D E F к L M N o 1 12000 60000 10% 3 90000 10% 10% 10% 10 ANDY 3 PAYMENT TODAY 4 Yearly Interest rate 5 No of Years 6 Pmt per Quarter 7 Pmt Amount 8 Rate per Quarter 9 nper BILL PAYMENT TODAY Yearly Interest rate No of Years Pmt Pmt Amount Rate yearly nper CHARLIE PAYMENT TODAY Yearly Interest rate No of Years Pmt per month Pmt Amount Rate per month nper End payment at 5th year DAN PAYMENT TODAY Yearly Interest rate No of Years Pmt per year Pmt Amount Rate per month nper End payment at 5th year 15000 10% 5 12 $ 1,800.00 0.008333333 10%/12 60 5*12 100000 EARL PAYMENT TODAY Yearly Interest rate No of Years 1 Pmt per Week Pmt Amount Rate per week nper 52 $ 10000 0.025 10%/4 12 4*3 $ 75,000.00 0.1 10%/1 11*1 25,000.00 0.1 10%/1 7 7*1 50000 $ 500.00 0.001923077 10%/52 520 52*10 10 PV for weekly payment $ 1,64,259.45 12 PV for quarterly pmt $ 1,02,577.65 13 Total PV $1,62,577.65 14 PV Total PV $ 68,181.82 $ 1,58,181.82 PV for monthly pmts Pv for End payment Total PV $ 84,717.66 $ 90,909.09 $ 1,90,626.76 PV for yearly payment Pv for End payment Total PV $ 1,21,710.47 $ 45,454.55 $ 1,79,165.02 Total PV $1,64,259.45 75 17 Mike should offer to sell to Charlie because his payments are offering the highest PRESENT VALUE to him. 18 19 NOTE: 1) PV formula= PV(rate,nper,-pmt) 20 where nper-No of period Rate= Rate of return pmt=no of payments 21 22 Incase of Charlie and Dan, we have calculated Present value twice to caculate End year payment and themonthly or yearly payment. 23 24 Incase of yearly payments, rate = 10%/1 25 Incase of monthly payments, rate = 10%/12 26 Incase of quarterly payments, rate=10%/4 27 Incase of weekly payments, rate=10%/52 28 29 alla