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 \(2,600,000, or it can make annual payments of \)300,000 for 15 years, each payment due on the last day of the year. Instructions Which method of payment do you recommend, assuming an expected effective interest rate of 8% during the future period?

Short answer

The recommended payment option will be the annual payments of $300,000 for 15 periods.

Step-by-step solution

First Option

The total payment is $2,600,000.

Computation of the second option

$$\begin{gathered} \mathbf{Present}\mathbf{}\mathbf{Value}\mathbf{}\mathbf{of}\mathbf{}\mathbf{annual}\mathbf{}\mathbf{payment}\mathbf{=}\mathbf{Annual}\mathbf{}\mathbf{Payment}\mathbf{\times }\mathbf{PV}\mathbf{}\mathbf{Factor} \\ \mathbf{=}\mathbf{300}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{8}\mathbf{.}\mathbf{55948} \\ \mathbf{=}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{567}\mathbf{,}\mathbf{844} \end{gathered}$$

The best payment option will be annual payments of $300,000.