Question
1. Tim Smith is shopping for a used luxury car. He has found one priced at...
1. Tim Smith is shopping for a used luxury car. He has found one priced at $36,000. The dealer has told Tim that if he can come up with a down payment of $5,500, the dealer will finance the balance of the price at a 8% annual rate over 2 years (24 months). (Hint: Use four decimal places for the monthly interest rate in all your calculations.)
a. Assuming that Tim accepts the dealer's offer, what will his monthly (end-of-month) payment amount be?
b. Use a financial calculator or spreadsheet to help you figure out what Tim's monthly payment would be if the dealer were willing to finance the balance of the car price at an annual rate of 3.5%?
2. What is the rate of return on an investment of $10,557 if the investor will receive $2,400 each year for the next 8 years?
3. Find the value of a bond maturing in 11 years, with a $1,000 par value and a coupon interest rate of 12% (6% paid semi-annually) if the required return on similar-risk bonds is 16% annual interest (8% paid semiannually).
4. The bond shown in the following table pays interest annually.
| Par value | Coupon interest rate | Years to maturity | Current value | |
| $100 | 12% | 20 | $130 |
Calculate the yield to maturity (YTM) for the bond.
5. Melissa is trying to value the stock of Generic Utility, Inc., which is clearly not growing at all. Generic declared and paid a $5 dividend last year. The required return for utility stocks is 8%, but Melissa is unsure about the financial reporting integrity of Generic's finance team. She decides to add an extra 2% "credibility" risk premium to the required return as part of her valuation analysis.
a. What is the value of Generic's stock, assuming that the financials are trustworthy?
b. What is the value of Generic's stock, assuming that Melissa includes the extra 2% "credibility" risk premium?
c. What is the difference between the values found in parts a and b, and how might one interpret that difference?
6. The Ball Shoe Company is considering an investment project that requires an initial investment of $537,000 and returns after-tax cash inflows of 96,166 per year for 10 years. The firm has a maximum acceptable payback period of 8 years.
a. Determine the payback period for this project.
b. Should the company accept the project?
7. Herky Foods is considering acquisition of a new wrapping machine. By purchasing the machine, Herky will save money on packaging in each of the next 5 years, producing the series of cash inflows shown in the following table:
Year Cash Flow
1 $ 595,200
2 $ 558,000
3 $ 446,400
4 $ 520,800
5 $ 297,600
The initial investment is estimated at $1.86 million. Using a 7% discount rate, determine the net present value (NPV) of the machine given its expected operating cash inflows. Based on the project's NPV, should Herky make this investment?
8. Neil Corporation has three projects under consideration. The cash flows for each of them are shown in the following table:
| Project A | Project B | Project C | |
| Initial investment: | $30,000 | $30,000 | $30,000 |
| Year: | |||
| 1 | $11,000 | $9,000 | $13,000 |
| 2 | $11,000 | $10,000 | $12,000 |
| 3 | $11,000 | $11,000 | $11,000 |
| 4 | $11,000 | $12,000 | $10,000 |
| 5 | $11,000 | $13,000 | $9,000 |
The firm has a cost of capital of 18%.
a. Calculate each project's payback period. Which project is preferred according to this method?
b. Calculate each project's net present value (NPV). Which project is preferred according to this method?
c. Comment on your findings in parts a and b, and recommend the best project. Explain your recommendation.
9. Thomas Company is considering two mutually exclusive projects. The firm, which has a cost of capital of 13%, has estimated its cash flows as shown in the following table:
| Project A | Project B | |
| Initial investment: | $130,000 | $100,000 |
| Year: | ||
| 1 | $15,000 | $55,000 |
| 2 | $30,000 | $40,000 |
| 3 | $45,000 | $30,000 |
| 4 | $60,000 | $5,000 |
| 5 | $70,000 | $15,000 |
a. Calculate the NPV of each project, and assess its acceptability.
b. Calculate the IRR for each project, and assess its acceptability.
10. The High-Flying Growth Company (HFGC) has been expanding very rapidly in recent years, making its shareholders rich in the process. The average annual rate of return on the stock in the past few years has been 24%, and HFGC managers believe that 24% is a reasonable figure for the firm's cost of capital. To sustain a high growth rate, HFGC's CEO argues that the company must continue to invest in projects that offer the highest rate of return possible. Two projects are currently under review. The first is an expansion of the firm's production capacity, and the second project involves introducing one of the firm's existing products into a new market. Cash flows from each project appear in the following table:
| Year | Plant Expansion | Product Introduction |
| 0 | -$3,100,000 | -$500,000 |
| 1 | $2,750,000 | $375,000 |
| 2 | $1,750,000 | $300,000 |
| 3 | $1,500,000 | $300,000 |
| 4 | $2,250,000 | $3755,000 |
a. Calculate the NPV for both projects. Rank the projects based on their NPVs.
b. Calculate the IRR for both projects. Rank the projects based on their IRRs.
c. Calculate the PI for both projects. Rank the projects based on their PIs.
d. The firm can only afford to undertake one of these investments. What should the firm do?
Answers
Answer 1
a. Calculation of monthly payment made by Tim Smith if interest rate is 8% p.a
Sr. No. Particulars Amount a Price of Car $36000 b Down Payment $5500 c Finance amount (a-b) $30500 d Interest rate p.a. 8% e Interest rate per month (8%/12 months) 0.667% f Duration of Finance 24 months g Present Value annuity Factor (0.667%, 24 months) 22.11 h Monthly installment (c/g) $1379.46 b. Calculation of monthly payment made by Tim Smith if Interest rate is 3.5% p.a
Sr. No. Particulars Amount a Price of Car $36000 b Down Payment $5500 c Finance amount (a-b) $30500 d Interest rate p.a. 3.5% e Interest rate per month (3.5%/12 months) 0.292% f Duration of Finance 24 months g Present Value annuity Factor (0.292%, 24 months) 23.15 h Monthly installment (c/g)
$1317.49Answer 3
Calculation of present value of bond having maturity 11 years
Year Particulars Cash Flow (a) Discounting Factor @ 8% (b) Present Value (c=a*b) 1-22 Interest $60 10.20 $612.00 22 Maturity $1000 0.1839 $183.90 Total $795.9 Answer 4-
Calculation of Yeild to maturity(YTM) of bond(Assuming bond is redeemed at par)
YTM = Interst+ (Redemption Value- Net Proceeds)/Maturity
(Redemption Value+Net Proceeds)/2
= $100*12%+ ($100-$130)/20 Years
($100+$130)/2
= $12-1.5/115*100
YTM = 9.13%
Answer 7;-
Calculation of NPV of Herky Food
Year Particulars Cash Flow
(a)
Discounting factor
@7 %
(b)
Present Value
(c= a*b)
0 Initial Investment -$18,60,000 1.00
-$18,60,000 1 Cash inflow $595200 0.935 $556512 2 Cash inflow $558000 0.873 $487134 3 Cash inflow $446400 0.816 $364262 4 Cash inflow $520800 0.763 $397370 5 Cash inflow $297600 0.713 $212189 NPV $157467 Decision-: As NPV is positive hence Herky Food should make the investment