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 $580,000 per year.If the discount rate is 7.5%,what will be the change in the value of the company if it chooses to go ahead with the sponsorship?

Question

Quizplus · Accepted Answer

The correct answer is A because the change in the value of the company is calculated as the present value of the expected cash flows minus the cost of the sponsorship. The present value of the expected cash flows is $580,000 x (1 - 1 / (1 + 0.075)^3) / 0.075 = $1,508,305. The cost of the sponsorship is $1 million. Therefore, the change in the value of the company is $1,508,305 - $1 million = $508,305.

An Auto-Parts Company Is Deciding Whether to Sponsor a Racing