Williams Warehousing currently has a warehouse lease that calls for five annual payments of $120,000. The warehouse owner, who needs cash, is offering Williams a deal wherein Williams will pay $200,000 this year and then pay only $80,000 each of the remaining 4 years. (Assume that all lease payments are made at the beginning of the year.) Should Williams Warehousing accept the offer if its required rate of return is 9 percent, and why? A) Yes, there is a savings of $45,494 in present value terms. B) Yes, there is a savings of $80,000 over the five years. C) No, there is an additional $80,000 payment in this year. D) Yes, there is a savings of $49,589 in present value terms.
PV of the current lease is 508,766 The deal proposed has a PV of 459,177 ==>Saving of $49,588 if offer is accepted. D
Possible Calculation: (I know there is an easier way, but I don’t have the documents with me right now) old NPV= 120000*(1,09^6-1,09)/(0,09*1,09^5) new NPV=200000+80000*(1,09^4-1)/(0,09*1,09^5) Calculate the difference and have the result… It is D: 49,588.80 Question is easy, but takes it’s time. With the right calculator it shouldn’t be a time problem at all.
If your using your calculator and having problems, make sure you set it to Begin mode.
D) is the correct answer. PV1 --> PMT = 120000, N = 5, I/Y = 9 multiplied by 1.09 (calculator at the END mode) gives us PV equals to 508766.39 PV2 --> CF0 = 200000, CF1 = 80000, F01 = 4, I/Y = 9 gives us PV equals to 459177.59 PV1 - PV2 = 49588.8 - choosing second option will allow Williams Warehousing to save this amount
TI-BA-2PLUS-PROFESSIONAL 2nd CF 2nd Clear Work CFo = -120K ENTER CF1 = -120K ENTER FO1 = 4 ENTER Press NPV Button I = 9 ENTER NPV = 00000 DOWN ARROW CPT SCENARIO-1 = - 508766.3852 2nd CF CFo = -200K ENTER CF1 = -80K ENTER Press NPV Button NPV DOWN ARROW CPT SCENARIO-2 = -459177.5902 He should definitely takeup the offer, he is saving on $49,589 with this deal - Dinesh S