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Answer :
To determine whether the value of the contract was equal to $125 million cash in hand in 2013, we need to understand the concept of present value.
Present value (PV) refers to the current value of a sum of money that is expected to be received in the future. It accounts for the time value of money, which recognizes that a dollar today is worth more than a dollar in the future due to its potential earning capacity. The present value can be calculated using the formula:
[tex]PV = \frac{C}{(1 + r)^n}[/tex]
Where:
- [tex]C[/tex] is the future cash flow or total payment.
- [tex]r[/tex] is the discount rate or interest rate.
- [tex]n[/tex] is the number of periods until the payment is received.
Let's evaluate the given options:
A. No, because $125 million is the sum of payments over the years, not the present value of the payments.
- This option is correct because $125 million refers to the total sum paid out over time, not its present value in 2013 unless properly discounted for time.
B. Yes, the tax benefits of the charity payment allow the $125 million to be considered present value.
- While tax benefits may affect the net value of a contract, they do not transform the sum into its present value. This explanation does not correctly address the concept of present value.
C. Yes, because $125 million is the total amount that will be paid out.
- Simply stating that the $125 million is the total amount paid does not account for the time value of money, thus it's not the present value.
D. No, because the payments are made at the end instead of the beginning of each year.
- Although the timing of payments impacts the calculation of the present value, this explanation alone is not sufficient to conclude that $125 million is not equivalent to the present value; it is more about the specific timing adjustment.
The best choice is A. The present value of the contract would need to be calculated by discounting the future payments to their value in 2013 to ascertain if they equate to $125 million cash in hand in 2013. Without this calculation, $125 million remains just the sum of future payments, not an equivalent immediate cash value.
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Rewritten by : Jeany
