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Unformatted text preview: FNAN 301 Solutions to test bank problems – time value of money part 2 Some answers may be slightly different than provided solutions due to rounding 1. Quality Real Estate owns a skyscraper that is expected to produce cash flows of $10 million in 1 year, $15 million in 2 years, and $220 million in 3 years, when it is expected to be sold. The cost of capital for the building is 15.0%. What is the value of the skyscraper? The value of the skyscraper is equal to the sum of the present values of its expected cash flows Step 1: cash flow is $10 million in 1 year, $15 million in 2 years, and $220 million in 3 years Step 2A: cash flows occur in 1, 2, and 3 years, and 1, 2, and 3 are whole numbers, so a year can be thought of as the largest period from this step Step 2B: no compounding period is given Step 2C: the cost of capital, which is the appropriate discount rate, is given for a year Step 2D: the shortest of the periods identified in steps 2A, 2B, and 2C is a year and is the length that each period on the timeline should reflect Step 3: the cost of capital is 15.0 percent per year Time 1 2 3 Cash flow $0 $10 million $15 million $220 million Present value ? PV = C + [C 1 / (1+r) 1 ] + [C 2 / (1+r) 2 ] + [C 3 / (1+r) 3 ] C = 0 C 1 = 10,000,000 C 2 = 15,000,000 C 3 = 220,000,000 r = .150 PV = 0 + [10,000,000 / (1.150) 1 ] + [15,000,000 / (1.150) 2 ] + [220,000,000 / (1.150) 3 ] = 0 + 8,695,652.17 + 11,342,155.01 + 144,653,571.14 = 164,691,378.32 The skyscraper is worth $164.7 million 1 FNAN 301 Solutions to test bank problems – time value of money part 2 2. You just bought a new car today. What is the present value of your cash flows if the discount rate is 12.3 percent, you will receive a rebate of $2,000 from the dealer in 2 years, and you will pay $40,000 to the dealer in 4 years? Note: the correct answer is less than zero. (http://www.youtube.com/watch?v=fS4_fkwv584 file:auto sale with rebate.wmv) (Fall 2009, quiz 1, question 6) (Fall 2009, final, question 2) (Spring 2010, quiz 1, question 2) (Spring 2010, final, question 1) (Summer C 2010, quiz 1, question 5) PV = C + [C 1 /(1+r) 1 ] + [C 2 /(1+r) 2 ] + [C 3 /(1+r) 3 ] + [C 4 /(1+r) 4 ] C = 0 C 1 = 0 C 2 = 2,000 C 3 = 0 C 4 = 40,000 r = .123 PV = 0 +[0/(1.123)] + [2,000/(1.123) 2 ] + [0/(1.123) 3 ] + [40,000/(1.123) 4 ] = 0 + 0 + 1,585.88 + 0 + (25,150.17) = $23,564.29 Solution – financial calculator Year 0 CF: present value = 0 Year 1 CF: present value = 0 Year 2 CF: N = 2; FV = 2000; I% = 12.3; PMT = 0; solve for PV = 1,585.88 so the present value of the cash flow = $1,585.88 Year 3 CF: present value = 0 Year 4 CF: N = 4; FV = 40000; I% = 12.3; PMT = 0; solve for PV = 25,150.17 so the present value of the cash flow = 25,150.17 Total present value of the cash flows = 0 + 0 + 1,585.88 + 0 + (25,150.17) = $23,564.29 Note that answers may differ slightly due to rounding 2 FNAN 301 Solutions to test bank problems – time value of money part 2 3. Arielle bought a new jet ski today from Wally’s Watersports Emporium. 3....
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 Spring '09
 MURRAY
 Time Value Of Money, Net Present Value

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