Question

An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $570,000 per year. If the discount rate is 6.9 %, what will be the change in the value of the company if it chooses to go ahead with the sponsorship?
A) $747,896
B) $797,756
C) $847,615
D) $498,597

Answer 1

Answer:

option (D) $498,597

Explanation:

Data provided in the question:

Cost of sponsoring the racing team = $1 million = $1,000,000

Expected increase in cash flow = $570,000

Discount rate = 6.9% = 0.069

Duration of sponsorship = 3 years

Now,

change in the value of the company

= [ $570,000 ÷ (1 + 0.069)¹ ] + [ $570,000 ÷ (1 + 0.069)² ] + [ $570,000 ÷ (1 + 0.069)³ ] - $1,000,000

= $53,3208.606 + $498791.961 + $46,6596.783 - $1,000,000

= $2,498,597.35 - $1,000,000

= $498,597.35 ≈ $498,597

Hence,

The answer is option (D) $498,597