CFP® Practice Question: How To Analyze A Buyout Offer

Mary and Penny were equal partners in the ownership of a gift shop but after several disagreements, have decided to terminate the partnership. Mary offers to purchase Penny’s interest by paying either $20,000 today or $35,000 five years from today. If Penny’s opportunity cost is 12% annually, which of the following options should Penny choose?

A. Take the $20,000 because it is $140.06 greater than the present value of the $35,000 five years from now.

B. Accept the $35,000 because it is $15,000 more than $20,000.

C. Accept the $20,000 because there is some uncertainty that Mary will honor the agreement five years from now.

D. Accept the $35,000 because its present value today is greater than the $20,000 by $140.06.

CLICK TO REVEAL ANSWER

The correct answer is A. The task here is to discount a future value, $35,000, to its present value at 12% for 5 years. On the HP-12C, enter 35000, FV, 12, i, 5, n, and press PV. On the HP-17B II, press 35000, the FV menu key, 12, the I%YR menu key, 5, the N menu key, and the PV menu key. On the BA-II Plus, press 35000, FV, 12, I/Y, 5, N, CPT, and PV. On the HP-10B II, press 35000, FV, 12, I/YR, 5, N, and PV. The answer, $19,859.94, will appear on the display, which is $140.06 less than $20,000. You could reach the same answer using the formula:

PV = FV

(1 + i)ⁿ

$35,000 ÷ (1.12)⁵ = $35,000 ÷ 1.7623 = $19,860.41

(Do not be concerned with slight differences in your answer if you use a formula or time value table vs. a calculator. These methods are less precise than a financial calculator due to rounding.) Since the present value of $35,000 is less than $20,000 in this case, B and D are incorrect. C is in correct because the uncertainty factor is implicit in the choice of 12% as the discount rate.

Posted in CFP® Practice Question

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