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Solution_Practice_Midterm1

# Solution_Practice_Midterm1 - Question1 a The two rates are...

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Question1 a) The two rates are not directly comparable, because they are both Stated Annual Rates and have different compounding periods. In order to compare the loans, we need to calculate the Effective Annual Rate for the two Loans. We will choose the lowest of the two rates. So, for the first loan we have that 1 + 𝐸𝐴𝑅 1 = 1 + 0.06 2 2 <=> 𝐸𝐴𝑅 1 = 0.0609 = 6.09% For the second loan we have that 1 + 𝐸𝐴𝑅 2 = 1 + 0.05 12 12 <=> 𝐸𝐴𝑅 2 = 0.0512 = 5.12% The Loan with the lowest rate is the second loan. The Loan will have 240 payments and a monthly interest rate of 5%/12=0.416%. To calculate the monthly payments we need to solve the following expression for C \$5,000,000 = 𝐶𝐴 0.416% 240 <=> 𝐶 = \$32,997.79 b) The amount of money you owe on your Loan is the Present Value of the payments still to be made. Ten years from now, there will be still 120 monthly payments of \$32,997,79 to be made. So, to liquidate the loan, you need to make a payment of 𝑃 = \$32,997.79 𝐴 0.416% 120 = \$3,111,076 Question 2 a) The first dividend that is relevant is the dividend coming next year. Since 2/3 of the Earnings are re-invested in the firm and earn a 9% rate of return, the Earnings are growing at a rate of 9%*2/3=6%. So, the first relevant Earnings is \$3.00*1.06=\$3.18. Since only one third is paid as dividends, the next dividend to be paid is \$1.06. The Earnings and, therefore, the dividends will grow at a rate of 6%.

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Solution_Practice_Midterm1 - Question1 a The two rates are...

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