rw6ech06_sol

# rw6ech06_sol - CHAPTER 6 DISCOUNTED CASH FLOW VALUATION...

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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. 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 PV@10% = \$1,200 / 1.10 + \$600 / 1.10 2 + \$855 / 1.10 3 + \$1,480 / 1.10 4 = \$3,240.01 PV@18% = \$1,200 / 1.18 + \$600 / 1.18 2 + \$855 / 1.18 3 + \$1,480 / 1.18 4 = \$2,731.61 PV@24% = \$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: X@5%: PVA = \$4,000{[1 – (1/1.05) 9 ] / .05 } = \$28,431.29 Y@5%: PVA = \$6,000{[1 – (1/1.05) 5 ] / .05 } = \$25,976.86 And at a 22 percent interest rate: X@22%: PVA = \$4,000{[1 – (1/1.22) 9 ] / .22 } = \$15,145.14 51

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Y@22%: PVA = \$6,000{[1 – (1/1.22) 5 ] / .22 } = \$17,181.84 Notice that the PV of Cash flow X has a greater PV at a 5 percent interest rate, but a lower PV at a 22 percent interest rate. The reason is that X has greater total cash flows. At a lower interest rate, the total cash flow is more important since the cost of waiting (the interest rate) is not as great. At a higher interest rate, Y is more valuable since it has larger cash flows. At the higher interest rate, these bigger cash flows early are more important since the cost of waiting (the interest rate) is so much greater. 3. To solve this problem, we must find the FV of each cash flow and add them. To find the FV of a lump sum, we use: FV = PV(1 + r) t FV@8% = \$800(1.08) 3 + \$900(1.08) 2 + \$1,000(1.08) + \$1,100 = \$4,237.53 FV@11% = \$800(1.11) 3 + \$900(1.11) 2 + \$1,000(1.11) + \$1,100 = \$4,412.99 FV@24% = \$800(1.24) 3 + \$900(1.24) 2 + \$1,000(1.24) + \$1,100 = \$5,249.14 Notice we are finding the value at Year 4, the cash flow at Year 4 is simply added to the FV of the other cash
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## This note was uploaded on 09/24/2009 for the course ECON 2298 taught by Professor Evans during the Spring '09 term at Langara.

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rw6ech06_sol - CHAPTER 6 DISCOUNTED CASH FLOW VALUATION...

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