1460T_c06.qxd1/10/0602:26 am Page296 EQA 296 Chapter 6 Accounting and the Time Value of Money (a)Derek Lee Inc.has $572,000 to invest.The company is trying to decide between two alternative uses of the funds.One alternative provides $80,000 at the end of each year for 12 years,and the other is to receive a single lump sum payment of $1,900,000 at the end of the 12 years.Which al- ternative should Lee select?Assume the interest rate is constant over the entire investment. (b) Derek Lee Inc.has completed the purchase of new Dell computers.The fair market value of the equipment is $824,150.The purchase agreement specifies an immediate down payment of $200,000 and semiannual payments of $76,952 beginning at the end of 6 months for 5 years.What is the interest rate,to the nearest percent,used in discounting this purchase transaction? (c) Derek Lee Inc.loans money to John Kruk Corporation in the amount of $600,000.Lee accepts an 8%note due in 7 years with interest payable semiannually.After 2 years(and receipt of interest for 2 years),Lee needs money and therefore sells the note to Chicago National Bank,which demands interest on the note of 10%compounded semiannually.What is the amount Lee will receive on the sale of the note? (d)Derek Lee Inc.wishes to accumulate $1,300,000 by December 31,2017,to retire bonds outstand- ing.The company deposits $300,000 on December 31,2007,which will earn interest at 10%com- pounded quarterly,to help in the retirement of this debt.In addition,the company wants to know how much should be deposited at the end of each quarter for 10 years to ensure that $1,300,000 is available at the end of 2017.(The quarterly deposits will also earn at a rate of 10%,compounded quarterly.)(Round to even dollars.) (L0 6,P6-8 (Analysis of Alternatives)Homer Simpson Inc.,a manufacturer of steel school lockers,plans to 7) purchase a new punch press for use in its manufacturing process.After contacting the appropriate ven- dors,the purchasing department received differing terms and options from each vendor.The Engineer- ing Department has determined that each vendor's punch press is substantially identical and each has a useful life of 20 years.In addition,Engineering has estimated that required year-end maintenance costs will be $1,000 per year for the first 5 years,$2,000 per year for the next 10 years,and $3,000 per year for the last 5 years.Following is each vendor's sale package. Vendor A:$45,000 cash at time of delivery and 10 year-end payments of $15,000 each.Vendor A offers all its customers the right to purchase at the time of sale a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of $10,000. ⊕ Vendor B:Forty seminannual payments of $8,000 each,with the first installment due upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at no extra charge Vendor C:Full cash price of $125,000 will be due upon delivery. Instructions Assuming that both Vendor A and B will be able to perform the required year-end maintenance,that Simpson's cost of funds is 10%,and the machine will be purchased on January 1,from which vendor should the press be purchased? (L05, P6-9 (Analysis of Business Problems)Jean-Luc is a financial executive with Starship Enterprises 6,7) Although Jean-Luc has not had any formal training in finance or accounting,he has a "good sense"for numbers and has helped the company grow from a very small company($500,000 sales)to a large oper- ation($45 million in sales).With the business growing steadily,however,the company needs to make a number of difficult financial decisions in which Jean-Luc feels a little "over his head."He therefore has decided to hire a new employee with"numbers"expertise to help him.As a basis for determining whom to employ,he has decided to ask each prospective employee to prepare answers to questions relating to the following situations he has encountered recently.Here are the questions. (a)In 2005,Starship Enterprises negotiated and closed a long-term lease contract for newly con- structed truck terminals and freight storage facilities.The buildings were constructed on land owned by the company.On January 1,2006,Starship took possession of the leased property.The 20-year lease is effective for the period January 1,2006,through December 31,2025.Advance rental payments of $800,000 are payable to the lessor (owner of facilities)on January 1 of each of the first 10 years of the lease term.Advance payments of $300,000 are due on January 1 for each of the last 10 years of the lease term.Starship has an option to purchase all the leased facilities for $1 on December 31,2025.At the time the lease was negotiated,the fair market value of the truck terminals and freight storage facilities was approximately $7,200,000.If the company had borrowed the money to purchase the facilities,it would have had to pay 10%interest.Should the company have purchased rather than leased the facilities? (b)Last year the company exchanged a piece of land for a non-interest-bearing note.The note is to be paid at the rate of $12,000 per year for 9 years,beginning one year from the date of disposal of the land.An appropriate rate of interest for the note was 11%.At the time the land was origi- nally purchased,it cost $90,000.What is the fair value of the note?(a) Derek Lee Inc. has $572,000 to invest. The company is trying to decide between two alternative uses of the funds. One alternative provides $80,000 at the end of each year for 12 years, and the other is to receive a single lump sum payment of $1,900,000 at the end of the 12 years. Which alternative should Lee select? Assume the interest rate is constant over the entire investment. (b) Derek Lee Inc. has completed the purchase of new Dell computers. The fair market value of the equipment is $824,150. The purchase agreement specifies an immediate down payment of $200,000 and semiannual payments of $76,952 beginning at the end of 6 months for 5 years. What is the interest rate, to the nearest percent, used in discounting this purchase transaction? (c) Derek Lee Inc. loans money to John Kruk Corporation in the amount of $600,000. Lee accepts an 8% note due in 7 years with interest payable semiannually. After 2 years (and receipt of interest for 2 years), Lee needs money and therefore sells the note to Chicago National Bank, which demands interest on the note of 10% compounded semiannually. What is the amount Lee will receive on the sale of the note? (d) Derek Lee Inc. wishes to accumulate $1,300,000 by December 31, 2017, to retire bonds outstanding. The company deposits $300,000 on December 31, 2007, which will earn interest at 10% compounded quarterly, to help in the retirement of this debt. In addition, the company wants to know how much should be deposited at the end of each quarter for 10 years to ensure that $1,300,000 is available at the end of 2017. (The quarterly deposits will also earn at a rate of 10%, compounded quarterly.) (Round to even dollars.) P6-8 (Analysis of Alternatives) Homer Simpson Inc., a manufacturer of steel school lockers, plans to purchase a new punch press for use in its manufacturing process. After contacting the appropriate vendors, the purchasing department received differing terms and options from each vendor. The Engineering Department has determined that each vendor’s punch press is substantially identical and each has a useful life of 20 years. In addition, Engineering has estimated that required year-end maintenance costs will be $1,000 per year for the first 5 years, $2,000 per year for the next 10 years, and $3,000 per year for the last 5 years. Following is each vendor’s sale package. Vendor A: $45,000 cash at time of delivery and 10 year-end payments of $15,000 each. Vendor A offers all its customers the right to purchase at the time of sale a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of $10,000. Vendor B: Forty seminannual payments of $8,000 each, with the first installment due upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at no extra charge. Vendor C: Full cash price of $125,000 will be due upon delivery. Instructions Assuming that both Vendor A and B will be able to perform the required year-end maintenance, that Simpson’s cost of funds is 10%, and the machine will be purchased on January 1, from which vendor should the press be purchased? P6-9 (Analysis of Business Problems) Jean-Luc is a financial executive with Starship Enterprises. Although Jean-Luc has not had any formal training in finance or accounting, he has a “good sense” for numbers and has helped the company grow from a very small company ($500,000 sales) to a large operation ($45 million in sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which Jean-Luc feels a little “over his head.” He therefore has decided to hire a new employee with “numbers” expertise to help him. As a basis for determining whom to employ, he has decided to ask each prospective employee to prepare answers to questions relating to the following situations he has encountered recently. Here are the questions. (a) In 2005, Starship Enterprises negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were constructed on land owned by the company. On January 1, 2006, Starship took possession of the leased property. The 20-year lease is effective for the period January 1, 2006, through December 31, 2025. Advance rental payments of $800,000 are payable to the lessor (owner of facilities) on January 1 of each of the first 10 years of the lease term. Advance payments of $300,000 are due on January 1 for each of the last 10 years of the lease term. Starship has an option to purchase all the leased facilities for $1 on December 31, 2025. At the time the lease was negotiated, the fair market value of the truck terminals and freight storage facilities was approximately $7,200,000. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest. Should the company have purchased rather than leased the facilities? (b) Last year the company exchanged a piece of land for a non-interest-bearing note. The note is to be paid at the rate of $12,000 per year for 9 years, beginning one year from the date of disposal of the land. An appropriate rate of interest for the note was 11%. At the time the land was originally purchased, it cost $90,000. What is the fair value of the note? 296 • Chapter 6 Accounting and the Time Value of Money (L0 6, 7) (L0 5, 6, 7) 1460T_c06.qxd 1/10/06 02:26 am Page 296