1 Shamrock Company recently signed a lease for a new office

1. Shamrock Company recently signed a lease for a new office building, for a lease period of 11 years. Under the lease agreement, a security deposit of $12,290 is made, with the deposit to be returned at the expiration of the lease, with interest compounded at 5% per year.

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What amount will the company receive at the time the lease expires? (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

2. Under the terms of his salary agreement, president John Walters has an option of receiving either an immediate bonus of $71,500, or a deferred bonus of $91,000 payable in 10 years.

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Ignoring tax considerations and assuming a relevant interest rate of 4%, which form of settlement should Walters accept?

Present value of deferred bonus $_________

Solution

Question 1:

The Amount the company receives at the end of the lease period is calculated by the formula:

Amount = Principal x (1+r)ⁿ

Explanation:

Amount = Amount we receive after n number of years

Principal = Amount deposited today

r= Compound interest rate

n= number of years deposit is made.

Therefore amount to be received by company after 11 years = $12290(1+0.05)¹¹ = $12290 x 1.71034 = $21020.

So the company will receive $21020 after 11 years.

Question 2: Whenever we compare two financial numbers we should consider time value of money. Immediate bonus of $71500 and deferred bonus of $91000 cannot be compared as it is. We need to consider time value of money and calculate the present value of deferred bonus and then compare.

The formula for calculating present value of an amount is Amount/(1+r)ⁿ

Explanation:

Amount = Future amount receivable

r = Interest Rate

n = number of years of deferrment

Therefore the present value of deferred bonus is $91000/(1+0.04)¹⁰ = $91000/(1.04)¹⁰ = $91000/1.48024 = $61,477

Since the present value of deferred bonus is less than the amount of immediate bonus Walters are recommended to accept immediate bonus form of settlement.

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