TVM:
Situation: You are the sales manager for Vending Associates, Inc., a small vending company in Columbia, SC. You are competing for the contract to provide vending services for a large account in the area and the account has narrowed its decision.
They will either select your small vending company with limited financial resources or a national vending company with very deep pockets (we'll call them BreakTime, Inc.). You know that most firms select vending companies based on the vending company's ability to provide a steady stream of commission payments to the firm. BreakTime, Inc has proposed an upfront payment of all estimated commissions totaling $53,000.
The contract up for bid has a time period of 5 years, after which, new bids will be accepted. You don't want to lose this bid, especially in this economy. However, you realize that Vending Associates (your company) can't afford to offer commission payments upfront.
You propose a settlement: Your company will provide $14,500 each year for the next 5 years of the contract, with the first payment coming at the end of the first year.
Since you have had a basic finance course with a great instructor, you know that you have to convince the buyers at the potential new account that your offer is better than your competitor's.
Based upon the fact that a dollar in hand today is worth more than a dollar in hand tomorrow, you decide to use time value of money techniques to sway the purchasing agents at the account in your company's direction. The rate that you will use for your presentation is 7.45%, indicative of investment opportunities in the current financial environment.
Required:
a. Draw a time line depicting the situation: 5 years, an interest rate of 7.45%, and payments of $14,500 at the end of each of those years.
b. Redraw the time line and discount the 5 ordinary annuity payments back to the present value at the 7.45% rate. (Compute the PV.)
c. If the present value of your future expected payments exceeds the offering of the competing project, then write about 8 to 10 sentences and try to convince the management team at the potential account to choose your vending company over the competition.
d. Now, from a perspective a little easier to see: Compound the competitor's offer of a single payment of $53,000 forward 5 years at 7.45% and compare its FV with the FV of your 5 end-of-year payments at 7.45%.
In other words, the potential account could either invest the $53,000 today and have an amount at the end of 5 years, or invest each of the 5 $14,500 at the end of each year and have an amount. The account will obviously want to choose the vending company offering the higher amount.