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Unformatted text preview: End of Chapter 3 Questions, Problems and Solutions CORPORATE FINANCE Professor Megginson Spring Semester 2003 Questions 3-1 What is the importance of understanding time value of money concepts for an individual? For a corporate manager? Can you think of a case where knowledge of time value of money would not be used to make a rational financial decision? 3-2 From a time value of money perspective, explain why the maximization of shareholder wealth and the maximization of profits may not offer the same result or course of action. 3-3 If a firm’s required return were 0 percent, would time value of money matter? As these returns rise above 0 percent, what impact would the increasing return have on future value? Present value? 3-4 What would happen to the future value of an annuity if interest rates fell in the late periods? Could the future value of an annuity factor formula still be used to determine the future value? 3-5 What happens to the present value of a cash flow stream when the discount rate increases? Place this in the context of an investment. If the required return on an investment goes up but the expected cash flows do not change, will you be willing to pay the same price for the investment or would you pay more or less for this investment than before interest rates changed? 3-6 Look at the formula for the present value of an annuity. What happens to the numerator as the number of periods increases? What distinguishes an annuity from a perpetuity? Why is there no future value of a perpetuity? 3-7 What is the relationship between the variables in a loan amortization and the total interest cost? Consider the variables of interest rates, amount borrowed, down payment, prepayment, and term of loan in answering this question. ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ *** ↓ Answers to End of Chapter 3 Questions 3.1. An individual wants to know time value of money techniques in order to compare investments. Which is better – stocks, bonds, preferred stock, real estate, etc.? A corporate manager uses time value of money to make the accept/reject decision for the firm’s projects. An example of where time value of money might not be used is if a company is required (environmental or safety) to take on a specified project. Then time value of money would not matter, since the company would have to make the investment to comply with government rules. 3.2. Maximizing profits might not be the same as maximizing shareholder wealth. Profits are an accounting number and can be manipulated. Usually there is a high correlation between profits and cash flows, but this does not necessarily have to be the case....
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