MT solution - MGCR 341 Finance 1 Summer 2010 Vadim di...

Info icon This preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
MGCR 341: Finance 1 Summer 2010 Vadim di Pietro Midterm: Solutions 1) (5 points, 5 mins) Would you rather invest your money for one year at an APR of 8% with monthly compounding, or in a 1-yr zero coupon bond that has a YTM of 8.4% ? (Assume both investments are risk free.) (1+0.08/12) 12 -1 = 0.083 < 0.084, thus you prefer to invest in the zero coupon bond. 2) (10 points, 15 mins) Today is year t = 0 . You are planning for your retirement. Assume that your first purchase in retirement will be made at t = 31 and your last purchase will be made at t = 70 . At t = 31 , you want to purchase the same amount of goods that $30,000 can buy today. Each year after that, you would like to be able to purchase 1% more, in real terms , than you did in the previous year. The annual inflation rate is 2% . The risk free rate is 10% . What is the Present Value of the cash flows you plan to spend in retirement? (You may solve this question using either the nominal approach or the real approach.) The cash flows are a forward starting growing annuity with a total of 40 cash flows. Nominal Approach: The first nominal cash flow at t = 31 is 30,000 (1.02) 31 = 55,427.66 If the real growth rate is 1%, and the inflation rate is 2%, then nominal cash flows have to grow at a rate of (1.01)(1.02)-1 = 0.0302 Thus PV = g2782g2782uni002Cg2781g2779g2784uni002Eg2783g2783 g2777uni002Eg2778g2777–g2777uni002Eg2777g2780g2777g2779 g3436g2778g3398g4672 g2778uni002Eg2777g2780g2777g2779 g2778uni002Eg2778g2777 g4673 g2781g2777 g3440g4672 g2778 g2778uni002Eg2778g2777 g2780g2777 g4673 = 42,202.74 The g4672 g2778 g2778uni002Eg2778g2777 g2780g2777 g4673 is included in this expression because we have to discount the value of the forward starting growing annuity back to t = 0. Recall that the standard formula for a growing annuity gives you the value of the cash flows one period before the first cash flow. Real Approach: The first real cash flow is 30,000, and the real growth rate is 1%. The real interest rate is 1.10/1.02 – 1 = 0.0784 Thus PV = g2780g2777uni002Cg2777g2777g2777 g2777uni002Eg2777g2784g2785g2781g2879g2777uni002Eg2777g2778 g3436g2778g3398g4672 g2778uni002Eg2777g2778 g2778uni002Eg2777g2784g2785g2781 g4673 g2781g2777 g3440g4672 g2778 g2778uni002Eg2777g2784g2785g2781 g2780g2777 g4673 = 42,202.74
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
3) (10 points, 15 mins) You are considering building a power plant. Today is t = 0 . Building the power plant will require a $4bn investment at t = 0 , and another $500M investment at t = 2 . Starting at t = 3 , there will be a maintenance cost each year. The maintenance cost at t = 3 is expected to be $60M , and is expected to grow by 3% each year thereafter. The project is expected to generate $300M in revenues at t = 6 , and revenues are expected to grow at a rate of X each year thereafter, forever.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern