Assignment

1. At an interest rate of 12%, the six-year discount factor is .507. How many dollars is $.507 worth in six
years if invested at 12%?
Compounding factor = 1/ discounting factor = 1/.507 = 1.972
FV = PV * FVIF(12,6)
FV = .507 *1.972 = 1
2. An investment of $232 will produce $312.18 in two years. What is the annual interest rate?
FV = 312.18
PV = 232
t = 2 years
FV = PV * FVIF(r, 2)
FVIF(r, 2) = 312.8/232 = 1.3482 ~ 16 %
3. An investment costs $1,548 and pays $138 in perpetuity. If the interest rate is 9%, what is the NPV?
PV (as per perpetuity paid )= 138/9 = 15.33
Present Cost = 1548
NPV = 1548 1533.33 = 14.67
4. You win a lottery with a prize of $1.5 million. Unfortunately, the prize is paid in 10 annual installments.
The first payment is next year. How much is the prize really worth? The discount rate is 8%.
Installment value (A) = 1.5 mn/10 = 150000
Discount rate = 8%
PV (of ordinary annuity ) = A * PFIFA(8,10)
= 150000* 6.7101 = 1006515
5. Want to be a millionaire? No problem! Suppose you are currently 21 years old, and can earn 10 percent
on your money (about what the typical common stock has averaged over the last six decades - but more
on that later). How much must you invest today in order to accumulate $1 million by the time you reach
age 65?
R = 10%
21----------------------------65
Value = 1000,000
FV = 1000000
R= 10%
T = 44
PV = FV * PVIF (10, 44)
= 1000000*.0151 = 15100
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6.Answer each of the following :

a.The cost of a new automobile is $10,000. If the interest rate is 5%, how much would you have to set aside
now to provide this sum in five years?
PV = 10,000 * PVIF(5,5) = .7835*10000 = 78350
b. You have to pay $12,000 a year in school fees at the end of each of the next six years. If the interest rate
is 8%, how much do you need to set aside today to cover these bills?
R= 8%
T=6
A = 12,000
PV = A* PVIFA(8,6) = 12000* 4.6229 = 55474.8
c.You have invested $60,476 at 8%. After paying the above school fees in (b ), how much would remain at
the end of the six years?
PV = 60476
R = 8%
T=6
FV = (60476 55474 )*FVIF(8,6) = 5002*1.5869 = 7936
7. The continuously compounded interest rate is 12%.
a.You invest $1,000 at this rate. What is the investment worth after five years?
FV = PV * e^.12*5 = 1000* 1.82212
b. What is the PV of $5 million to be received in eight years?
PV = FV / e^.12*8 = 5000000/2.6117 = $1.91 mn
c.What is the PV of a continuous stream of cash flows, amounting to $2,000 per year, starting immediately
and continuing for 15 years?
e.12 1 = .127
PV = 2000*PVIFA(.127,15) = $13127.63

8. You are quoted an interest rate of 6% on an investment of $10 million. What is the value of your
investment after four years if the interest rate is compounded:
a.annually
FV = 10mn * FVIF(6,4)
b. monthly
FV = 10mn * FVIF(6/12,48)
c.continuously?
FV = 10 mn * e.06*4
9. An investment will increase by 270% over the next 17 years. What is the annual nominal rate which when
compounded quarterly provides this return ?
FV = PV ( 1+r/4)4*17
FV = 3.70*PV
3.70 = (1+.25r)68
1+r/4 = 1.0194
r = 7.76%

10. A factory costs $800,000. You reckon that it will produce an inflow after operating costs of $170,000 a
year for 10 years. If the opportunity cost of capital is 14%, what is the net present value of the factory?
What will the factory be worth at the end of five years?
Cost = 800000
Cash Flow (A) = 170,000
T = 10
R =14%
PV = A* PVIFA(14,10)
= 170000* 5.2161 = 886737
NPV = 886737 -800000 = $86737
Net worth = PV (at the end of five years ) = 170000* PVIFA(14,5) = 170000*3.4331 = 583627

11. Mr Baba is 65 years of age and has a life expectancy of 12 years. He wishes to invest $20,000 in an
annuity that will make a level payment at the end of each year until his death. If the interest rate is 8%,
what income can Mr. Baba expect to receive each year?
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Cash Flow (A)= ?

PV = 20000
R = 8%
T = 12
A= PV * FVIFA(8,12) = 20000*2.5182 = 50364

12. Kangaroo Autos is offering free credit on a new $10,000 car. You pay $1,000 down and then $300 a
month for the next 30 months. Turtle Motors next door does not offer free credit but will give you
$1,000 off the list price. If the rate of interest is 10% a year, which company is offering the better deal?
Kangaroo
Down payment = 1000
Cash flow (A) = 300
T =30
R = 10/12 = .83
Using Excel : $7938
Total paid = 1000+ $7938 = $8938
Turtle :
Total cost = 10000 1000 = 9000
Kangaroo offers better deal with difference of $62
13. For an investment of $1,000 today, the Tiburon Finance Company is offering to pay you $1,600 at the
end of 8 years. What is the annually compounded rate of interest? What is the continuously compounded
rate of interest?
a)
PV = 1000
FV = 1600
T = 8 years
1600/1000 = (1+r)8
1.6 1/8 = 1+r
r = 6.05%
b)

1.6 = er
r = ln(1.6) = 4.70%

14.You have just read an advertisement stating, "Pay us $100 a year for 10 years and we will pay you $100 a
year thereafter in perpetuity." If this is a fair deal, what is the rate of interest?
Considering ordinary annuity
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Cash Flow (A) = 100

T =10
FV = A* FVIFA(r, 10) .eq 1
PV = 100/r eq 2
Given eq1 =eq2
FVIFA(r,10) = 1/r
(1+r)10 1 = 1
r = 2.1 1 = 7.17%

15. While vacationing in Hammamet Beach, Mamet saw the vacation home of his dreams. It was listed with a
sale price of $200,000. The only catch is that Mamet is 40 years old and plans to continue working until he is
65. Still, he believes that prices generally increase at the overall rate of inflation. Mamet believes that he can
earn 9% annually after taxes on
his investments. He is willing to invest a fixed amount at the end of each of the next 25 years to fund the cash
purchase of such a house (one that can be purchased today for $200,000) when he retires.
a. Inflation is expected to average 5% a year for the next 25 years. What will Mamet's dream house cost
when he retires?
FV(house) = 20000* FVIF(5,25) = $67,7270.99
b. How much must Mamet invest at the end of each of the next 25 years in order to have the cash purchase
price of the house when he retires?
FV = A * FVIFA(9,25)
FV = $677,270.99
A = $677,270.99/84.70 = $7,996.03
c. If Mamet invests at the beginning instead of at the end of each of the next 25 years, how much must he
invest each year?
A = Answer of (b)/1.09 = 14190/1.09 = 13018
16. You are asked to put a value on a bond, which promises 8 annual payments of $50 and will repay its face value
of $1000 at the end of 8 years. You observe that other similar bonds have yields to maturity of 9%.
a) How much is this bond worth?
PV of bond = 50* PVIFA(9%,8) + 1000* PVIF(9%,8)
= $276.74 + $501.87 = $778.61

b) What should you be willing to pay for that bond if 2 years remain to maturity and the yield remains the
same?
PV = 50* PVIFA(9%, 2) + 1000* PVIF(9%,2)
= $87.96 + $841.68 = $929.64
17. What is the value of a consol that pays $250 every 6 months when the annual market interest rate is 14%?
Rate = 14% (annual) = 7% semi annually
Dividend = $250
PV = D/r = 250/.07 = $3571.42
18. You are thinking about investing in a $1000 face value bond which will mature in two years. The bond has
an 8% coupon and pays interest semiannually. The current yield to maturity on similar bonds is 6%, and rates
are not expected to change. What is the bond's price today and after each interest payment?
Maturity = 2 years
Coupon = 8%
Face value = $1000
Coupon cash flow = 4% * 1000 = 40
Opportunity cost (r) = 6% annually = 3% semi annually
PV = 40 * PVIFA(3,4) + 1000* PVIF(3,4) = $1,037.17

19.Company X is expected to pay dividends of $5.50 a share in 1 year's time and $5.80 share in 2 years' time, after
which its stock is expected to sell at $91. Do you buy the stock if it is currently traded at 105$? Assume an
opportunity cost of 10%.
Dividend = $5.50 per share
r = 10%
PV = 5.50*PVIF(10,1) + 5.80 * PVIF(10,2) + 91* PVIF(10,2) = $85
Stock is overpriced so it is not worth to buy the stock

20.You forecast that the Royal Bank's earnings will be $4.8 billion next year. The policy of the bank is to keep 50%
of the earnings as retained earnings. What price would you expect to see for Royal Bank stock if the opportunity
cost is 15% and that dividends will grow at a rate of 9% a year? Assume 1 billion shares in circulation.
Retention ratio = 50% = .5
R = 15%
Growth rate = 9 %
#shares = 1 bn
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Earning = $4.8 bn
EPS = 4.8
DPS = 1 retention ratio = 1 - .5 = .5
Dividend pay out = .5 * EPS = .5 * 4.8 = 2.4
PV = D1/ r g = 2.4 / .15 - .09 = 2.4 /.06 = 40

21. The Scene: Early evening in an ordinary family room in Manhattan. Modern furniture with old copies of
the Wall Street Journal and the Financial Times scattered around. Autographed photos of Alan Greenspan and
Georges Soros are prominently displayed. A picture window reveals a distant view of lights on the Hudson
River. John Jones sits at a computer terminal, glumly sipping a glass of chardonnay and trading Japanese yen
over the Internet. His wife Marsha enters.
Marsha: Hi, honey. Glad to be home. Lousy day on the trading floor, though. Dullsville. No volume. But I did
manage to hedge next year's production from our copper mine. I couldn't get a good quote on the right package
of futures, contracts, so I arranged a commodity swap.
John doesn't reply.
Marsha: John, what's wrong? Have you been buying yen again? That's been a losing trade for weeks.
John: Well, yes. I shouldn't have gone to Goldman Sachs's foreign exchange brunch. But I've got to get but of
the house somehow. I'm cooped up here all day calculating covariances and efficient risk-return tradeoffs while
you're out trading commodity futures. You get all the glamour and excitement.
Marsha: Don't worry dear, it will be over soon. We only recalculate our most efficient common stock portfolio
once a quarter. Then you can go back to leveraged teases.
John: You trade, and I do all the worrying. Now there's a rumor that our leasing company is going to get a
hostile takeover bid.
I knew the debt ratio was too low, and you forgot to put on the poison pill. And now you've made a
negative-NPV investment!
Marsha: What investment?
John: Two more oil wells in that old field in Ohio. You spent $500,000! The wells only produce 20 barrels of
crude oil per day.
Marsha: That's 20 barrels day in, day out. There are 365 days in a year, dear.
John and Marsha's teenage son Johnny bursts into the room.
Johnny: Hi, Dad! Hi, Mom! Guess what? I've made the junior varsity, derivatives team! That means I can go on
the field trip to the Chicago Board Options Exchange. (Pauses.) What's wrong?
John: Your mother has made another negative-NPV investment. More oil wells.
Johnny: That's OK, Dad. Mom told me about it. I was going to do. an NPV calculation yesterday, but my
corporate finance teacher asked me to calculate default probabilities for a sample of junk bonds for Friday's
class. (Grabs a financial calculator from his backpack) Let's see: 20 barrels per day times $15 per barrel times
365 days per year . . . that's $109,500 per year.
John: That's $109,500 this year. Production's been declining at 5 percent every year.
Marsha: On the other hand, our energy consultants project increasing oil prices. If they increase with inflation,
price per barrel should climb by roughly 2.5 percent per year. The wells cost next to nothing to operate, and they
should keep pumping for 10 more years at least.
Johnny: I'll calculate NPV after I finish with the default probabilities. Is a 9 percent nominal cost of capital
OK?
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Marsha: Sure, Johnny.

John: (Takes a deep breath and stands up.) Anyway, how about a nice family dinner? I've reserved our usual
table at the Four Seasons.
Everyone exits.
Announcer: Were the oil wells really negative-NPV? Will John and Marsha have to fight a hostile takeover?
Will Johnny's derivatives team use Black-Scholes or the binomial method? Find out in the next episode of The
Jones Family, Incorporated.
You may not aspire to the Jones familys way of life, but you will learn about all their activities from futures
contracts to binomial option pricing later if you go into Finance concentration. Meanwhile, you may wish to
replicate Johnnys NPV analysis.
Cost = $500,000
R = 9%
a. Forecast future cash flows, taking account of the decline in production and the (partially) offsetting
forecasted increase in oil prices.
b. What is the PV of the Wells production assuming the wells keep producing for ever?
c. What is the PV of the Wells production assuming the wells only produce for ten years?

22. Spreadsheet Modeling

Check for details on how to build spreadsheet modeling on the icon Using Excel in Corporate Finance (page
19) on Webctvista Home page.
Write your own excel program to calculate the NPV of the following:
A project requires a current investment of $100.00 and yields future expected cash flows of $21.00, $34.00,
$40.00, $33.00, and $17.00 in periods 1 through 5, respectively. All figures are in thousands of dollars. For
these expected cash flows, the appropriate discount rate is 8.0%.
You will get an output similar to the following using the steps described below: