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Sample_Problems

Sample_Problems - Sample Problems Question 1...

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Sample Problems
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Question 1 Congratulations, you have won the lottery! Now $10 million richer, you have a choice between two options: ten payments of $1 million every year (starting today); or an up-front payment of $7 million. Which should you take, assuming the current risk- free rate is 5%?
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Question 1 Need to use the annuity formula. This will take care of the nine future payments. We then add in the one immediate payment. So C = 1, r = 0.05, T = 9. This sum comes to 7.1, so the value of the payment stream is 8.1 million. ( 29 + - × = r r C PV T 1 1 1
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Question 2 Let’s value Westwood Financial, a local commercial bank, using the dividend discount model. Westwood will pay $6M in dividends out of $10M in net income next year. It’s growth is stable, increasing earnings at 4% per year in perpetuity. Use an 8% discount rate. (a) What is the value of the company’s equity?
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Question 2 Need to use the dividend discount model for growing dividends.
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