Question

When Pacific Inc. bid for a project with the government, the company was offered the following two payment options:

Option (A): A payment of $837,500 at the end of 4 years, which is the scheduled completion time for the project.

Option (B): $220,000 paid upfront at the beginning of the project and the balance payment in 4 years.

If the two payments are financially equivalent and the interest rate is 3.48% compounded semi-annually, calculate the balance payment offered in Option(B)

Answer 1

Upfornt Payment in Option (B) = $220,000

Interest Rate = 3.48% p.a compounded semi - annually

Number of Years = 4

m = 2 (2 semi annual periods in a year)

Value of Upfront Payment after 4 years = Upfornt Payment * (1 + Interest Rate / m)^{(Number of Years * m)}

Value of Upfront Payment after 4 years = 220,000 * (1 + 3.48% / 2)^{(4 * 2)}

Value of Upfront Payment after 4 years = $252,555

Balalnce Payment after 4 Years = Payment under option (A) - Value of Upfront Payment in Option (B)

Balalnce Payment after 4 Years = 837,500 - 252,555

Balalnce Payment after 4 Years = $584,945

Balance Payment Offered in Option (B) should be $584,945.