Assignment_1_Valuation_and_Valuing_Bonds_A.pdf - Assignment...

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Assignment 1: Basic Valuation Concepts and Valuing Bonds Handed Out: 2/1/2019, 5 pm 1. All investments are riskless. The rate of discount is 9%. A die cutter that pays $150 per year for 17 years and has a salvage value of $100 at the end of year 17 can be purchased for $1290 today. a. What is the NPV of the machine? b. What if the discount rate changes to 10% right at end of the first year. Assume the machine is riskless again. How much is the machine worth at that time? a. PV of cash inflows = CF/r*[1 – 1/(1+r)^T] + SV(17)/(1+r)^T = $150/.09*[1-1/(1+.09)^17] +$100/(1+.09)^17 = $1304 NPV = $1304 - $1290 = $14 b. PV of cash inflows = CF/r*[1 – 1/(1+r)^T] + SV(17)/(1+r)^T = $150/.10*[1-1/(1+.10)^16] +$100/ (1+.10)^16 = $1194.8 NPV = $1195 - $1290*(1.09) = -$211. This was a little tricky. There’s only 16 years left to this machine. Also, C(0) = $1290 becomes C(1)=1290 *1.09. The rate was 9% per annum in the first year. Note: I assume that the problem is still riskless. If there was a possibility that the discount rate could change, the problem wouldn’t be riskless. 2. You have money to invest today. What are the PVs of the following investments? The annual rate of interest is 9%. All assets are risk-free. a. An annuity that pays $7 per year for 17 years. b. A UST strip that pays $250 at the end of 17 years. c. A perpetuity that pays $4 at the end of the first year and then grows at 4% per year.
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