Solutions_Ch06

Solutions_Ch06 - CHAPTER 6 B-65 CHAPTER 6 DISCOUNTED CASH...

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CHAPTER 6 B-65 CHAPTER 6 DISCOUNTED CASH FLOW VALUATION Answers to Concepts Review and Critical Thinking Questions 1. The four pieces are the present value (PV), the periodic cash flow ( C ), the discount rate ( r ), and the number of payments, or the life of the annuity, t . 2. Assuming positive cash flows, both the present and the future values will rise. 3. Assuming positive cash flows, the present value will fall and the future value will rise. 4. It’s deceptive, but very common. The basic concept of time value of money is that a dollar today is not worth the same as a dollar tomorrow. The deception is particularly irritating given that such lotteries are usually government sponsored! 5. If the total money is fixed, you want as much as possible as soon as possible. The team (or, more accurately, the team owner) wants just the opposite. 6. The better deal is the one with equal installments. 7. Yes, they should. APRs generally don’t provide the relevant rate. The only advantage is that they are easier to compute, but, with modern computing equipment, that advantage is not very important. 8. A freshman does. The reason is that the freshman gets to use the money for much longer before interest starts to accrue. 9. The subsidy is the present value (on the day the loan is made) of the interest that would have accrued up until the time it actually begins to accrue. 10. The problem is that the subsidy makes it easier to repay the loan, not obtain it. However, ability to repay the loan depends on future employment, not current need. For example, consider a student who is currently needy, but is preparing for a career in a high-paying area (such as corporate finance!). Should this student receive the subsidy? How about a student who is currently not needy, but is preparing for a relatively low-paying job (such as becoming a college professor)?
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B-66 SOLUTIONS Solutions to Questions and Problems NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem. Basic 1. To solve this problem, we must find the PV of each cash flow and add them. To find the PV of a lump sum, we use: PV = FV / (1 + r) t [email protected]% = $1,200 / 1.10 + $600 / 1.10 2 + $855 / 1.10 3 + $1,480 / 1.10 4 = $3,240.01 [email protected]% = $1,200 / 1.18 + $600 / 1.18 2 + $855 / 1.18 3 + $1,480 / 1.18 4 = $2,731.61 [email protected]% = $1,200 / 1.24 + $600 / 1.24 2 + $855 / 1.24 3 + $1,480 / 1.24 4 = $2,432.40 2. To find the PVA, we use the equation: PVA = C ({1 – [1/(1 + r) ] t } / r ) At a 5 percent interest rate: [email protected]%: PVA = $4,000{[1 – (1/1.05) 9 ] / .05 } = $28,431.29 [email protected]%: PVA = $6,000{[1 – (1/1.05) 5 ] / .05 } = $25,976.86 And at a 22 percent interest rate: [email protected]%: PVA = $4,000{[1 – (1/1.22) 9 ] / .22 } = $15,145.14
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This homework help was uploaded on 02/19/2008 for the course H ADM 222 taught by Professor Qma during the Fall '07 term at Cornell.

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Solutions_Ch06 - CHAPTER 6 B-65 CHAPTER 6 DISCOUNTED CASH...

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