Bergon Corporation's management took the following actions, which went into effect on March 2, 2011. Each action involved an application of present value.
a. Entered into a purchase agreement that calls for a payment of $500,000 three years from now.
b. Bought out the contract of a member of top management for a payment of $50,000 per year for four years beginning March 2, 2012.
REQUIRED
1. Assuming an annual interest rate of 10 percent answer the following questions:
a. In action a, what is the present value of the liability for the purchase agreement?
b. In action b, what is the cost (present value) of the buyout?
2. Many businesses analyze present value extensively when making decisions about long-term assets. Why is this type of analysis particularly appropriate for such decisions?