Question

Assume that Sonic Foundry Corporation has a contractual debt outstanding. Sonic has available two means of settlement. It can either make immediate payment of $2,673,000, or it can make annual payments of $347,100 for 15 years, each payment due on the last day of the year.

Which method of payment do you recommend, assuming an expected effective interest rate of 10% during the future period?

Answer 1

Available methods of payment are as follows:

Option (I): Immediate payment of $2,673,000.

Option (II): Annual payments of $347,100 for 15 years, each payment due on the last day of the year.

Whereas effective interest rate: 10%.

Hence, Present Value of all future payments = PVAIF (10, 15) * $347,100 = 7.6061 * $347,100 = $2,640,077 (approx).

It is clear from the above analysis that net present value of all outflow is lower in method (II) of payment at $2,640,077. Hence, it is recommended to make annual payment of $347,100 for 15 years at the end of each year.