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Problem Set I Solution

# Problem Set I Solution - Problem Set I Solutions Time Value...

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Problem Set I Solutions Time Value of Money and Stock and Bond Valuation Problem 1 The cash flows can be broken into three separate cash flows patterns: 1. a single cash flow at the end of three years Discount Rate = 10% Present Value (PV at t=0) is \$g2869g2868g2868g2868 (g2869g2878g2868.g2869) g3119 = \$751 2. an annuity beginning at the end of fourth year and continuing for next ten years Discount Rate = 8% Present Value (PV at t=3) is \$g2869g2868g2868g2868 g2868.g2868g2876 xg46761− g2869 (g2869g2878g2868.g2868g2876) g3117g3116 g4677 = \$6,710 Present Value (PV at t=0) is \$g2874g2875g2869g2868 (g2869g2878g2868.g2869) g3119 = \$5,041 3. and a perpetuity beginning at the end of fourteenth year Discount Rate = 6% Present Value (PV at t=13) is \$g2869g2868g2868g2868 g2868.g2868g2874 = \$16,666 Present Value (PV at t=3) is \$g2869g2874,g2874g2874g2874 (g2869g2878g2868.g2876) g3117g3116 = \$7,719 Present Value (PV at t=0) is \$g2875,g2875g2869g2877 (g2869g2878g2868.g2869) g3119 = \$5,800 Therefore, Present Value (PV) is \$751 + \$5,041 + \$ 5,800 = \$11,592 Problem 2 This represents a growing annuity with: Interest Rate r = 0.7% per month Growth Rate g = 0.3% per month Number of withdrawals t = 48 Present Value (PV) = \$30,000 C represents the amount of first withdrawal Therefore, Hence, you can withdraw \$690.03 after the first month of college. 03 . 690 \$ 007 . 1 003 . 1 1 003 . 007 . 000 , 30 \$ 1 1 1 48 = + + = + + = C C r g g r C PV t

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Problem 3 Bank pays an annual interest rate of 10% compounded semi-annually. The EAR (Effective Annual Rate) = (1+ g3045 g3041 ) g3041 − 1 = (1+ g2868.g2869 g2870 ) g2870 − 1 = 10.25 % Part a The cash flow represents a \$100,000 annuity with ten periods (n=10) Present Value (PV at t = -1) of this annuity is g3004 g3045 xg46761− g2869 (g2869g2878g2928) g3172 g4677 = \$g2869g2868g2868,g2868g2868g2868 g2868.g2869g2868g2870g2873 xg46761− g2869 (g2869g2878g2868.g2869g2868g2870g2873) g3117g3116 g4677 = \$607,912 Future Value (FV at t = 25) of this annuity is \$607,912 x (1+0.1025) g2870g2874 = \$7,685,724 Therefore, you will have \$7,685,724 in the bank account after 25 years. Part b Let each deposit be C Present Value (PV at t = -1) of this annuity is g3004 g3045 xg46761− g2869 (g2869g2878g2928) g3172 g4677 = \$g2869g2868g2868,g2868g2868g2868 g2868.g2869g2868g2870g2873 xg46761− g2869 (g2869g2878g2868.g2869g2868g2870g2873) g3117g3116 g4677 = C x 6.079 Present Value (PV at t = -1) of \$5 million to be received after 25 years is \$g2873,g2868g2868g2868,g2868g2868g2868 (g2869g2878g2868.g2869g2868g2870g2873) g3118g3122 = \$395,482 Therefore, C x 6.079 = \$395,482 i.e. C = \$65,056 Hence, each deposit should be equal to \$65,056 Problem 4 The cash flows can be broken into two separate cash flows patterns: 1. an annuity beginning at the end of first year and continuing for next ten years Discount Rate = 8% Present Value (PV at t=0) is \$g2869g2873g2868g2868 g2868.g2868g2876 xg46761− g2869 (g2869g2878g2868.g2868g2876) g3117g3116 g4677 = \$10,065 2. and a perpetuity beginning at the end of tenth year Discount Rate = 6% Present Value (PV at t=10) is \$g2869g2873g2868g2868 g2868.g2868g2874
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