Net present Value

omron

Hi, I am setting up my own business and am wanting to learn how or which option to go for in investment terms, mainly for decision making purposes. I am wondering if someone could give me an answer to the problem below to see if it matches with mine. Thanks for all inputs

You are considering the purchase of a motorised caravan from Bluebird limited.
The company offer two means of purchase:

Payment of the full purchase price of £55000 plus a recommended service agreement and extended guarantee costing £500 per year or an initial deposit of 20% of the purchase price plus 8 annual payments of £8700 plus a finance arrangement fee of 2% of the purchase price.

a) Assuming that the cost of capital is 10% use the NPV method to evaluate which option represents the most economic choice.

ArcSine

You know the drill for homework problems: You show your work and your proposed answer (or explain where you're stuck), and then you get assistance.

iNinjaNotes

Your going to have to PV the lump sums, and contrast them against the payment option which is the PV of an annuity.

the equations are..

FV = PV(1+r)^t which is future value = pv * (1 + discount rate) to the power of years.
Rearrange this formula to solve for PV.

PV of an annuity is..

PV = [1-[1/ (1+r)^t ] divide by r ] multiply by payments.

so that means. do this.. (1+ discount rate) to the power of terms.
next, 1 divide by the result of the first step.
next, 1 minus the result of the last 2 steps.
next, divide the result by discount rate.
next, multiply the result by the payments, like the car payments.

Then compare the PV of each and see which has a greater cost.