Suppose you have been hired as an independent contractor for

Suppose you have been hired as an independent contractor for a company to help with implementation of a new software system. You have been asked to layout the timeline for the deliverables of the project and the costs. In the timeline, the company would like to pay you half of the contract value at the end of one year and half at the end of the second year. The other option is to pay you 25% of the contract value at the beginning, 50% at the end of the first year and the remaining 25% at the end of the second year. Suppose the total value of the contract is $60,000 and the market interest rates is 2%. Calculate the present value of each option and determine which option would you choose. Explain why.

Solution

In option one

50% of 60,000 in the 1st year

50% of 60,000 in the 2nd year

Means 30,000 in 1st year and 30,000 in 2nd year

Present Value will be = 30,000(P/A, 2%, 2)

Present Value will be = 30,000(1.942) = 58,260

In option two

25% of 60,000 in the now

50% of 60,000 in the 1st year

25% of 60,000 in the 2nd year

Means now 15,000, 1st year = 30,000 and 2nd year = 15000

Present Value will be = 15,000 + 30,000(P/F, 2%,1) + 15,000(P/F, 2%, 2)

Present Value will be = 15,000 + 30,000(.9804) + 15,000(.9612) =58,830

Present value in option one is 58,260

Present value in option one is 58,830

2nd option is to be choose because of getting more present value. By selecting the 2nd option the contractor is getting more money.